Attached files
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EX-32 - EXHIBIT 32 - EMULEX CORP /DE/ | c95186exv32.htm |
EX-31.A - EXHIBIT 31A - EMULEX CORP /DE/ | c95186exv31wa.htm |
EX-31.B - EXHIBIT 31B - EMULEX CORP /DE/ | c95186exv31wb.htm |
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended December 27, 2009
OR
o | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File No. 001-31353
EMULEX CORPORATION
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) |
51-0300558 (I.R.S Employer Identification No.) |
|
3333 Susan Street Costa Mesa, California (Address of principal executive offices) |
92626 (Zip Code) |
(714) 662-5600
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer: þ | Accelerated filer: o | Non-accelerated filer: o | Smaller reporting company: o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
As of January 21, 2010, the registrant had 80,987,352 shares of common stock outstanding.
EMULEX CORPORATION AND SUBSIDIARIES
INDEX
PAGE | ||||||||
3 | ||||||||
4 | ||||||||
5 | ||||||||
6 | ||||||||
19 | ||||||||
34 | ||||||||
34 | ||||||||
34 | ||||||||
37 | ||||||||
50 | ||||||||
50 | ||||||||
51 | ||||||||
52 | ||||||||
Exhibit 31A | ||||||||
Exhibit 31B | ||||||||
Exhibit 32 |
2
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(unaudited, in thousands, except share data)
December 27, | June 28, | |||||||
2009 | 2009 | |||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 252,737 | $ | 294,136 | ||||
Investments |
16,086 | 8,289 | ||||||
Accounts and other receivables, net of
allowance for doubtful accounts of $1,611
and $1,553 as of December 27, 2009 and June
28, 2009, respectively |
68,207 | 51,566 | ||||||
Inventories |
10,717 | 10,665 | ||||||
Prepaid income taxes |
17,300 | 17,083 | ||||||
Prepaid expenses and other current assets |
9,047 | 8,021 | ||||||
Deferred income taxes |
16,289 | 16,793 | ||||||
Total current assets |
390,383 | 406,553 | ||||||
Property and equipment, net |
67,020 | 74,794 | ||||||
Goodwill |
87,840 | 87,840 | ||||||
Intangible assets, net |
50,143 | 42,990 | ||||||
Deferred income taxes |
22,844 | 16,002 | ||||||
Other assets |
45,680 | 30,739 | ||||||
Total assets |
$ | 663,910 | $ | 658,918 | ||||
Liabilities and Stockholders Equity |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 24,834 | $ | 28,786 | ||||
Accrued liabilities |
31,385 | 23,454 | ||||||
Total current liabilities |
56,219 | 52,240 | ||||||
Other liabilities |
5,495 | 5,826 | ||||||
Accrued taxes |
32,666 | 31,408 | ||||||
Total liabilities |
94,380 | 89,474 | ||||||
Commitments and contingencies (Note 8) |
||||||||
Stockholders equity: |
||||||||
Preferred stock, $0.01 par value; 1,000,000
shares authorized (150,000 shares designated
as Series A Junior Participating Preferred
Stock); none issued and outstanding |
| | ||||||
Common stock, $0.10 par value; 240,000,000
shares authorized; 90,639,793 and 89,668,255
issued at December 27, 2009 and June 28,
2009, respectively |
9,064 | 8,967 | ||||||
Additional paid-in capital |
1,112,464 | 1,106,990 | ||||||
Accumulated deficit |
(383,290 | ) | (396,070 | ) | ||||
Accumulated other comprehensive loss |
(468 | ) | (443 | ) | ||||
Treasury stock, at cost; 10,550,971 and
8,550,971 shares at December 27, 2009 and
June 28, 2009, respectively |
(168,240 | ) | (150,000 | ) | ||||
Total stockholders equity |
569,530 | 569,444 | ||||||
Total liabilities and stockholders equity |
$ | 663,910 | $ | 658,918 | ||||
See accompanying notes to condensed consolidated financial statements.
3
Table of Contents
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(unaudited, in thousands, except per share data)
Three Months Ended | Six Months Ended | |||||||||||||||
December 27, | December 28, | December 27, | December 28, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net revenues |
$ | 108,290 | $ | 108,661 | $ | 193,817 | $ | 220,357 | ||||||||
Cost of sales |
41,506 | 42,676 | 74,927 | 84,420 | ||||||||||||
Gross profit |
66,784 | 65,985 | 118,890 | 135,937 | ||||||||||||
Operating expenses: |
||||||||||||||||
Engineering and development |
31,680 | 31,101 | 63,079 | 65,884 | ||||||||||||
Selling and marketing |
15,760 | 13,270 | 28,672 | 27,786 | ||||||||||||
General and administrative |
11,896 | 9,548 | 24,175 | 18,964 | ||||||||||||
Amortization of other intangible assets |
1,698 | 1,851 | 3,396 | 3,938 | ||||||||||||
Total operating expenses |
61,034 | 55,770 | 119,322 | 116,572 | ||||||||||||
Operating income (loss) |
5,750 | 10,215 | (432 | ) | 19,365 | |||||||||||
Nonoperating (expense) income, net: |
||||||||||||||||
Interest income |
93 | 1,224 | 212 | 3,073 | ||||||||||||
Interest expense |
(2 | ) | (34 | ) | (4 | ) | (36 | ) | ||||||||
Other (expense) income, net |
(132 | ) | (127 | ) | 98 | 197 | ||||||||||
Total nonoperating (expense) income, net |
(41 | ) | 1,063 | 306 | 3,234 | |||||||||||
Income (loss) before income taxes |
5,709 | 11,278 | (126 | ) | 22,599 | |||||||||||
Income tax (benefit) provision |
(3,233 | ) | 761 | (12,906 | ) | 4,581 | ||||||||||
Net income |
$ | 8,942 | $ | 10,517 | $ | 12,780 | $ | 18,018 | ||||||||
Net income per share: |
||||||||||||||||
Basic |
$ | 0.11 | $ | 0.13 | $ | 0.16 | $ | 0.22 | ||||||||
Diluted |
$ | 0.11 | $ | 0.13 | $ | 0.16 | $ | 0.22 | ||||||||
Number of shares used in per share computations: |
||||||||||||||||
Basic |
79,667 | 80,169 | 79,563 | 80,604 | ||||||||||||
Diluted |
80,734 | 80,420 | 80,505 | 81,055 | ||||||||||||
See accompanying notes to condensed consolidated financial statements.
4
Table of Contents
EMULEX CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited, in thousands)
Six Months Ended | ||||||||
December 27, | December 28, | |||||||
2009 | 2008 | |||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 12,780 | $ | 18,018 | ||||
Adjustments to reconcile net income to net cash provided by (used
in) operating activities: |
||||||||
Depreciation and amortization of property and equipment |
10,567 | 10,950 | ||||||
Share-based compensation expense |
8,564 | 12,519 | ||||||
Amortization of intangible assets |
12,847 | 13,399 | ||||||
Provision for losses on accounts and other receivables |
58 | (36 | ) | |||||
Accrued interest income, net |
37 | 683 | ||||||
Loss (gain) on disposal of property and equipment |
769 | (94 | ) | |||||
Deferred income taxes |
(8,447 | ) | (5,570 | ) | ||||
Excess tax benefit from share-based compensation |
(206 | ) | (188 | ) | ||||
Foreign currency adjustments |
(86 | ) | (157 | ) | ||||
Changes in assets and liabilities: |
||||||||
Accounts and other receivables |
(16,697 | ) | (3,804 | ) | ||||
Inventories |
(123 | ) | 4,468 | |||||
Prepaid expenses and other assets |
(5,971 | ) | (2,457 | ) | ||||
Accounts payable, accrued liabilities, and other liabilities |
4,684 | (9,742 | ) | |||||
Accrued taxes |
1,258 | 3,319 | ||||||
Income taxes payable and prepaid income taxes |
(223 | ) | (52,008 | ) | ||||
Net cash provided by (used in) operating activities |
19,811 | (10,700 | ) | |||||
Cash flows from investing activities: |
||||||||
Net proceeds from sale of property and equipment |
168 | 50 | ||||||
Purchases of property and equipment |
(4,685 | ) | (14,512 | ) | ||||
Purchases of intangible assets |
(20,000 | ) | | |||||
Investment in and loans to privately-held companies |
(10,000 | ) | (947 | ) | ||||
Purchases of investments |
(24,585 | ) | (97,715 | ) | ||||
Maturities of investments |
16,751 | 176,392 | ||||||
Net cash (used in) provided by investing activities |
(42,351 | ) | 63,268 | |||||
Cash flows from financing activities: |
||||||||
Repurchase of common stock |
(18,240 | ) | (39,913 | ) | ||||
Tax withholding payments reimbursed by common stock |
(3,468 | ) | (2,416 | ) | ||||
Proceeds from issuance of common stock under stock plans |
2,687 | 3,850 | ||||||
Excess tax benefit from share-based compensation expense |
206 | 188 | ||||||
Net cash used in financing activities |
(18,815 | ) | (38,291 | ) | ||||
Effect of exchange rates on cash and cash equivalents |
(44 | ) | (33 | ) | ||||
Net (decrease) increase in cash and cash equivalents |
(41,399 | ) | 14,244 | |||||
Cash and cash equivalents at beginning of period |
294,136 | 217,017 | ||||||
Cash and cash equivalents at end of period |
$ | 252,737 | $ | 231,261 | ||||
See accompanying notes to condensed consolidated financial statements.
5
Table of Contents
EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements (unaudited)
1. | Basis of Presentation |
In the opinion of management of Emulex Corporation (Emulex or the Company), the accompanying
unaudited condensed consolidated financial statements contain all adjustments (which are normal
recurring accruals) necessary to present fairly the Companys consolidated financial position,
results of operations, and cash flows. Interim results for the six months ended December 27, 2009,
are not necessarily indicative of the results that may be expected for the fiscal year ending June
27, 2010. The accompanying condensed consolidated interim financial statements should be read in
conjunction with the Companys Annual Report on Form 10-K for the fiscal year ended June 28, 2009.
The preparation of the condensed consolidated financial statements requires the use of estimates
and actual results could differ materially from managements estimates. The Company has evaluated
subsequent events through January 29, 2010.
Certain reclassifications have been made to prior period amounts to conform to the current
periods presentation.
Supplemental Cash Flow Information
Six Months Ended | ||||||||
December 27, | December 28, | |||||||
2009 | 2008 | |||||||
(in thousands) | ||||||||
Cash paid during the period for: |
||||||||
Interest |
$ | 3 | $ | 5 | ||||
Income taxes |
$ | 247 | $ | 60,905 | ||||
Non-cash activities: |
||||||||
Purchases of property and equipment not paid, net |
$ | 1,016 | $ | 779 |
Recently Adopted Accounting Standards
In December 2007, the Financial Accounting Standards Board (FASB) issued authoritative
guidance for business combinations changing the accounting for business combinations in a number of
areas including the treatment of contingent consideration, contingencies, acquisition costs,
in-process research and development, and restructuring costs. In addition, changes in deferred tax
asset valuation allowances and acquired income tax uncertainties in a business combination after
the measurement period will impact income taxes. In April 2009, the FASB amended the December 2007
guidance related to the initial recognition and measurement, subsequent measurement and accounting,
and disclosures for assets and liabilities arising from contingencies assumed in business
combinations. The April 2009 guidance eliminates the distinction between contractual and
non-contractual contingencies, including the initial recognition and measurement criteria and
instead carries forward most of the provisions in place before the December 2007 guidance was
issued. The December 2007 and April 2009 guidance is effective prospectively for the Companys
fiscal year beginning June 29, 2009, and impacts the accounting for any business combinations
entered into after the effective date. There was no financial statement impact of the Companys
adoption of this guidance on June 29, 2009.
In December 2007, the FASB issued authoritative guidance for noncontrolling interests in
consolidated financial statements changing the accounting and reporting for minority interests.
Minority interests will be recharacterized as noncontrolling interests and will be reported as a
component of equity separate from the parents equity and purchases or sales of equity interests
that do not result in a change in control will be accounted for as equity
transactions. In addition, net income attributable to the noncontrolling interest will be
included in consolidated net income on the face of the income statement and, upon a loss of
control, the interest sold as well as any interest retained will be recorded at fair value with any
gain or loss recognized in earnings. This guidance will apply prospectively, except for the
presentation and disclosure requirements, which will apply retrospectively. This guidance is
effective for the Companys fiscal year beginning June 29, 2009, and impacts the accounting for and
presentation of noncontrolling interests after the effective date. There was no financial statement
impact of the Companys adoption of this guidance on June 29, 2009 as the Company did not have any
noncontrolling interests.
6
Table of Contents
In December 2007, the FASB ratified Accounting Standard Codification (ASC) 808, Collaborative
Arrangements that prohibits companies from applying the equity method of accounting to activities
performed outside a separate legal entity by a virtual joint venture. Instead, revenues and costs
incurred with third parties in connection with the collaborative arrangement should be presented
gross or net by the collaborators based on the criteria in previously issued guidance on reporting
revenue gross as a principal versus net as an agent and other applicable accounting literature. The
consensus should be applied to collaborative arrangements in existence at the date of adoption
using a modified retrospective method that requires reclassification in all periods presented for
those arrangements still in effect at the transition date, unless that application is
impracticable. The consensus is effective for the Companys fiscal year beginning June 29, 2009.
There was no financial statement impact of the Companys adoption of ASC 808 on June 29, 2009.
In April 2008, the FASB issued authoritative guidance for determining the useful life of
intangible assets amending the guidance for estimating the useful lives of recognized intangible
assets and requiring additional disclosures related to renewing or extending the terms of
recognized intangible assets. This guidance is effective for the Companys fiscal year beginning
June 29, 2009. There was no financial statement impact of the Companys adoption of this guidance
on June 29, 2009.
In June 2008, the FASB issued authoritative guidance for determining whether instruments
granted in share-based payment transactions are participating securities. The Company adopted this
guidance during the three months ended September 27, 2009. See Note 12.
In November 2008, the FASB issued authoritative guidance for accounting for defensive
intangible assets requiring entities to account for a defensive intangible asset as a separate unit
of accounting at the time of acquisition, not combined with the acquirers existing recognized or
unrecognized intangible assets. This consensus is effective for the Companys fiscal year beginning
June 29, 2009, and impacts the accounting for intangible assets acquired after the effective date.
There was no financial statement impact of the Companys adoption of this guidance on June 29,
2009.
In June 2009, the FASB issued ASC 105, Generally Accepted Accounting Principles (GAAP),
which amends the GAAP hierarchy established under Statement of Financial Accounting Standards
(SFAS) No. 162. On July 1, 2009, the FASB launched the FASB Accounting Standards Codification,
superseding all existing non-SEC accounting and reporting standards. ASC 105 is effective in the
first interim and annual periods ending after September 15, 2009, or the Companys first quarter of
fiscal year 2010 ended September 27, 2009. Following this statement, the FASB will issue new
standards in the form of Accounting Standards Updates (ASUs). The Companys adoption of ASC 105 in
the interim period ended September 27, 2009 had no financial statement impact other than the
specific references to U.S. GAAP.
Recently Issued Accounting Standards
In September 2009, the FASB issued authoritative guidance for revenue arrangements with
multiple deliverables. In the absence of vendor-specific objective evidence (VSOE) or other third
party evidence (TPE) of the selling price for the deliverables in certain multiple-element
arrangements, companies are required to use an estimated selling price for the individual
deliverables. Companies shall apply the relative-selling price model for allocating an
arrangements total consideration to its individual elements. Under this model, the estimated
selling price is used for both the delivered and undelivered elements that do not have VSOE or TPE
of the selling price. This consensus will be effective prospectively for revenue arrangements
entered into or materially modified in fiscal years beginning on or after June 15, 2010, or the
Companys 2011 fiscal year. Early adoption is permitted. The Company has not adopted this guidance
and is currently assessing the impact of adoption.
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Table of Contents
In September 2009, the FASB issued authoritative guidance for certain revenue arrangements
that include software elements amending previous guidance on software revenue recognition to
exclude from its scope tangible products that contain both software and non-software components
that function together to deliver a products essential functionality. This guidance will be
effective prospectively for revenue arrangements entered into or materially modified in fiscal
years beginning on or after June 15, 2010, or the Companys 2011 fiscal year. Early adoption is
permitted. The Company has not adopted this guidance and is currently assessing the impact of
adoption.
2. Fair Value of Financial Instruments
Fair value is defined as the exchange price that would be received for an asset or paid to
transfer a liability (an exit price) in the principal or most advantageous market for the asset or
liability in an orderly transaction between market participants on the measurement date. Valuation
techniques used to measure fair value must maximize the use of observable inputs and minimize the
use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which
the first two are considered observable and the last unobservable, that may be used to measure fair
value. A description of the three levels of inputs is as follows:
Level 1 | | Quoted prices in active markets for identical assets or liabilities; | ||||
Level 2 | | Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and | ||||
Level 3 | | Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. |
Financial instruments measured at fair value on a recurring basis as of December 27, 2009 and
June 28, 2009 are as follows:
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
(in thousands) | ||||||||||||||||
December 27, 2009 |
||||||||||||||||
Cash and cash equivalents |
$ | 252,737 | $ | | $ | | $ | 252,737 | ||||||||
Term deposits |
2,238 | | | 2,238 | ||||||||||||
U.S. Government securities |
5,496 | | | 5,496 | ||||||||||||
U.S. Government sponsored entity securities |
8,349 | | | 8,349 | ||||||||||||
$ | 268,820 | $ | | $ | | $ | 268,820 | |||||||||
June 28, 2009 |
||||||||||||||||
Cash and cash equivalents |
$ | 294,136 | $ | | $ | | $ | 294,136 | ||||||||
Municipal bonds |
152 | | | 152 | ||||||||||||
U.S. Government securities |
4,097 | | | 4,097 | ||||||||||||
U.S. Government sponsored entity securities |
4,058 | | | 4,058 | ||||||||||||
$ | 302,443 | $ | | $ | | $ | 302,443 | |||||||||
The Companys other financial instruments consist primarily of a note receivable, equity
investment in privately-held company, and insurance recovery receivable. The Company believes the
carrying value of its insurance recovery receivable approximates its current fair value due to its
nature and relatively short duration. The fair value of the Companys investment in privately-held
company is not readily available and a reasonable estimate of fair value could not be made without
incurring excessive costs. The fair value of the Companys note receivable is based on management
judgment using market-based interest rates, and is believed to approximate its carrying value. The
fair value is determined based on Level 3 inputs which require the use of inputs that are both
unobservable and significant to the fair value measurements.
8
Table of Contents
3. Investments
The Companys portfolio of held-to-maturity investments consists of the following:
Gross | Gross | |||||||||||||||
Unrealized | Unrealized | |||||||||||||||
Cost | Gains | Losses | Fair Value | |||||||||||||
(in thousands) | ||||||||||||||||
December 27, 2009 |
||||||||||||||||
Term deposits |
$ | 2,241 | $ | | $ | (3 | ) | $ | 2,238 | |||||||
U.S. Government securities |
5,497 | | (1 | ) | 5,496 | |||||||||||
U.S. Government sponsored entity securities |
8,348 | 1 | | 8,349 | ||||||||||||
$ | 16,086 | $ | 1 | $ | (4 | ) | $ | 16,083 | ||||||||
June 28, 2009 |
||||||||||||||||
Municipal bonds |
$ | 151 | $ | 1 | $ | | $ | 152 | ||||||||
U.S. Government securities |
4,097 | | | 4,097 | ||||||||||||
U.S. Government sponsored entity securities |
4,041 | 17 | | 4,058 | ||||||||||||
$ | 8,289 | $ | 18 | $ | | $ | 8,307 | |||||||||
Investments at December 27, 2009 and June 28, 2009 were classified as short-term investments
due to the investments having maturity dates of less than one year.
4. Inventories
Inventories are summarized as follows:
December 27, | June 28, | |||||||
2009 | 2009 | |||||||
(in thousands) | ||||||||
Raw materials |
$ | 4,315 | $ | 4,330 | ||||
Finished goods |
6,402 | 6,335 | ||||||
$ | 10,717 | $ | 10,665 | |||||
5. Goodwill and Intangible Assets, net
There was no goodwill activity during the six months ended December 27, 2009.
Intangible assets, net, are as follows:
December 27, | June 28, | |||||||
2009 | 2009 | |||||||
(in thousands) | ||||||||
Intangible assets subject to amortization: |
||||||||
Core technology and patents |
$ | 72,145 | $ | 92,228 | ||||
Accumulated amortization, core technology and patents |
(47,674 | ) | (82,381 | ) | ||||
Developed technology |
68,500 | 77,312 | ||||||
Accumulated amortization, developed technology |
(44,525 | ) | (46,488 | ) | ||||
Customer relationships |
38,670 | 38,670 | ||||||
Accumulated amortization, customer relationships |
(37,548 | ) | (37,227 | ) | ||||
Tradename |
4,639 | 4,639 | ||||||
Accumulated amortization, tradename |
(4,064 | ) | (3,763 | ) | ||||
$ | 50,143 | $ | 42,990 | |||||
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The decrease in core and developed technology during the six months ended December 27, 2009,
was primarily due to approximately $48.9 million in core and developed technology being fully
amortized and written off. The remaining increase in core technology and patents is due to a
patent licensing agreement entered into with a third party for approximately $20.0 million.
The intangible assets subject to amortization are being amortized on a straight-line basis
over original lives ranging from approximately five to seven years. Aggregated amortization expense
for intangible assets for the three months ended December 27, 2009 and December 28, 2008, was
approximately $6.4 million and $6.6 million, respectively. Aggregated amortization expense for
intangible assets for the six months ended December 27, 2009 and December 28, 2008, was
approximately $12.8 million and $13.4 million, respectively.
Amortization expense of approximately $4.7 million related to core and developed technology is
included in cost of sales in the accompanying condensed consolidated statements of income for both
the three months ended December 27, 2009 and December 28, 2008. Amortization expense related to
core and developed technology included in cost of sales in the accompanying condensed consolidated
statements of income for both the six months ended December 27, 2009 and December 28, 2008 was
approximately $9.5 million.
The following table presents the estimated future aggregated amortization expense of
intangible assets as of December 27, 2009 (in thousands):
2010 (remaining 6 months) |
$ | 12,847 | ||
2011 |
21,711 | |||
2012 |
7,585 | |||
2013 |
4,000 | |||
2014 |
4,000 | |||
Thereafter |
| |||
$ | 50,143 | |||
6. Other Assets
Components of other assets are as follows:
December 27, | June 28, | |||||||
2009 | 2009 | |||||||
(in thousands) | ||||||||
Note receivable |
$ | 24,466 | $ | 15,000 | ||||
Equity investment in privately-held company |
11,184 | 11,184 | ||||||
Other |
10,030 | 4,555 | ||||||
$ | 45,680 | $ | 30,739 | |||||
In March 2009, the Company loaned $15.0 million to a privately-held company. The note
receivable bears simple interest at 5.0% per annum. In December 2009, the Company increased the
loan by $10.0 million and extended the maturity date to the earlier of December 31, 2010 or certain
defined events such as consummation of financing, change in control, or default. The note
receivable is collateralized by substantially all of the assets of the privately-held company.
The Companys equity investment in a privately-held company is accounted for under the cost
method. Under the cost method, investments are carried at cost and are adjusted for
other-than-temporary declines in fair value, distributions of earnings, or additional investments.
The Company monitors its investment for impairment on a quarterly basis and makes appropriate
reductions in carrying values when such impairments are determined to be other-than-temporary.
Impairment charges are included in other (expense) income, net in the consolidated statements of
income. Factors used in determining an impairment include, but are not limited to, the current
business environment including competition; uncertainty of financial condition; technology and
product prospects; results of operations; and current financial position including any going
concern considerations such as the rate at which the investee utilizes cash and the investees
ability to obtain additional financing. The Company has determined that
there is no impairment as of December 27, 2009. However, it is considered reasonably possible
that the Companys determination that there is no impairment could change if the current business
environment deteriorates, if the investees financial condition worsens, or the investee is unable
to secure adequate financing to support its business plan and operations.
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7. Accrued Liabilities
Components of accrued liabilities are as follows:
December 27, | June 28, | |||||||
2009 | 2009 | |||||||
(in thousands) | ||||||||
Payroll and related costs |
$ | 17,125 | $ | 11,410 | ||||
Warranty liability |
1,926 | 2,462 | ||||||
Deferred revenue and accrued rebates |
3,939 | 3,499 | ||||||
Other |
8,395 | 6,083 | ||||||
$ | 31,385 | $ | 23,454 | |||||
The Company provides a warranty of between one and five years on its products. The Company
records a provision for estimated warranty-related costs at the time of sale based on historical
product return rates and the Companys estimates of expected future costs of fulfilling its
warranty obligations. Changes to the warranty liability were:
(in thousands) | ||||
Balance as of June 28, 2009 |
$ | 2,462 | ||
Accrual for warranties issued |
488 | |||
Changes to pre-existing warranties (including changes in estimates) |
(461 | ) | ||
Settlements made (in cash or in kind) |
(563 | ) | ||
Balance as of December 27, 2009 |
$ | 1,926 | ||
8. Commitments and Contingencies
Litigation
On November 15, 2001, prior to the Companys acquisition of Vixel Corporation, a securities
class action was filed in the United States District Court in the Southern District of New York as
Case No. 01 CIV. 10053 (SAS), Master File No. 21 MC92 (SAS) against Vixel and two of its officers
and directors (one of which is James M. McCluney, the Companys current Chief Executive Officer and
President) and certain underwriters who participated in the Vixel initial public offering in late
1999. The amended complaint alleges violations under Section 10(b) of the Exchange Act and Section
11 of the Securities Act and seeks unspecified damages on behalf of persons who purchased Vixel
stock during the period October 1, 1999 through December 6, 2000. In October 2002, the parties
agreed to toll the statute of limitations with respect to Vixels officers and directors until
September 30, 2003, and on the basis of this agreement, Vixels officers and directors were
dismissed from the lawsuit without prejudice. During June 2003, Vixel and the other issuer
defendants in the action reached a tentative settlement with the plaintiffs that would, among other
things, result in the dismissal with prejudice of all claims against the defendants and their
officers and directors. In connection with the possible settlement, those officers and directors
who had entered tolling agreements with the plaintiffs agreed to extend those agreements so that
they would not expire prior to any settlement being finalized. Although Vixel approved this
settlement proposal in principle, it remained subject to a number of procedural conditions, as well
as formal approval by the court. On August 31, 2005, a Preliminary Order In Connection With
Settlement Proceedings was issued by the court which among other items, set a date for a Settlement
Fairness Hearing held on April 24, 2006, and the form of notice to the Settlement Classes of the
Issuers Settlement Stipulation. In December 2005, the settlement notices authorized by the court
were sent to former Vixel stockholders and the web site www.iposecuritieslitigation.com was created
for claimants, as well as a March 24, 2006 objection deadline. At the Settlement Fairness Hearing
held on April 24, 2006, the court raised the following primary issues: (1) the (possible) change in
value of the settlement since preliminary approval, and whether the benefits of the
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settlement
should be evaluated at the time of approval or at the time of
negotiation; (2) how the class certification argument before the Second Circuit Court of Appeals could or would affect the
fairness of the settlement; (3) how to evaluate the intangible benefits of the settlement to the
class members; and (4) how to value the $1 billion guarantee (for the consolidated litigation
involving Vixel and 297 other Issuers) by insurers in the stipulation and agreement of settlement
in light of the underwriters potential future settlements. The Court did not rule on April 24,
2006 on the motion for final approval or objections. On June 6, 2006, the Second Circuit Court of
Appeals held oral arguments on the appeal by the underwriters of Judge Scheindlins class
certification decision. On or about July 17, 2006, Emulex assigned to the class action plaintiffs
any IPO claims that Emulex (Vixel) had against RBC Dain Rauscher in the IPO litigation, as required
by the settlement agreement. On December 5, 2006, the Second Circuit Court of Appeals issued a
decision reversing Judge Scheindlins class certification decision. On December 14, 2006, Judge
Scheindlin issued an order to stay all proceedings pending a decision from the Second Circuit on
whether it will hear further argument. On about January 6, 2007, Emulex assigned to the class
action plaintiffs any IPO claims that Emulex (Vixel) had against The Bear Stearns Companies Inc.
and Bear Stearns & Co. Inc. in the IPO litigation, as required by the settlement agreement. On
April 6, 2007, the Second Circuit denied the plaintiffs petition for rehearing of the decision
denying class certification. During April 2007, counsel for Emulex and other Issuers informed Judge
Scheindlin that, in light of the Second Circuit opinion, the settlement agreement could not be
approved because the defined settlement class, like the litigation class, did not meet the Second
Circuit requirements for certification. Judge Scheindlin held a conference on May 30, 2007 to
consider issues relating to the class definitions, the statute of limitations, settlement, and
discovery. On June 25, 2007, Judge Scheindlin signed a Stipulation and Order submitted by the
parties which terminated the June 10, 2004 Stipulation and Agreement of Settlement with Defendant
Issuers and Individuals. On June 26, 2007, a document production request from the plaintiffs to all
298 issuers (including Vixel) was received, covering documents from each issuers inception through
December 31, 2001. In September 2007, due to the expiration of the tolling agreements, those
officers and directors who had entered tolling agreements with the plaintiffs agreed to extend
those agreements until August 27, 2010. On November 15, 2007, the issuers and their respective
insurers entered into an Insurers-Insureds Agreement (replacing an earlier agreement), which
provides for the insurers to pay for certain defense costs under applicable issuer insurance
policies. On December 21, 2007, issuer defendants filed an opposition to plaintiffs motion for
class certification of certain focus cases. On March 26, 2008, defendants motion to dismiss was
denied except to certain claims by plaintiffs who did not suffer damages or whose claims were time
barred. On Oct. 10, 2008, Judge Scheindlin signed an order granting the plaintiffs request to
withdraw the class certification motion in the six focus cases (Emulex/Vixel is not in a focus
case). On April 1, 2009, the parties signed a Stipulation and Agreement of Settlement (the 2009
Settlement) which the District Court subsequently approved on October 6, 2009. The 2009
Settlement provides for a settlement amount of $586 million, and Emulex has no obligation to pay
any part of that amount. On October 23, 2009, Lester Baum, Mike Hart, and Sue Shadley filed a
petition for permission to appeal the class certification order.
On January 27, 2009, a patent infringement lawsuit was filed in the United States District
Court in the Central District of California as Case No. CV09-00605 R (JWJx) against Emulex by
Microprocessor Enhancement Corporation and Michael H. Branigin. The complaint alleges infringement
of U.S. Patent No. 5,471,593, and seeks a judgment for damages, injunctive relief, and an award of
attorneys fees and costs. On March 25, 2009, Emulex filed an answer to the complaint denying
allegations and asserting affirmative defenses. On Oct. 13, 2009, the Company filed documents
opposing a summary judgment motion by the Plaintiffs. A hearing of the summary judgment motion was
held on Nov. 16, 2009, and the motion was taken under submission.
On April 27, 2009, Reid Middleton filed a lawsuit in the Court of Chancery of the State of
Delaware on behalf of himself and all other similarly situated stockholders of the Company and
derivatively on behalf of the Company. The original complaint named the members of the Board as
defendants and the Company as a nominal defendant. The complaint asserted a claim for breach of
fiduciary duty on behalf of a putative class of holders of shares of the Companys common stock
(the Shares) and a derivative claim for devaluation of the Company stemming from the Companys
January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to replace its
expiring rights plan, and amendments to its Key Employee Retention Agreements, and actions in
response to Broadcoms announcement of its unsolicited April 21, 2009 takeover proposal to acquire
the Company. The original complaint sought declaratory and injunctive relief, compensatory damages,
interest and costs, including attorneys and expert fees.
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On May 6, 2009, Jim Robbins filed a lawsuit in the Superior Court of the State of California,
County of Orange, on behalf of himself and all other similarly situated stockholders of the Company
(the California Litigation). The complaint names the members of the Board and the Company as defendants. The complaint asserts
a claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to
the Companys January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to
replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and
actions in response to Broadcoms announcement of its proposal to acquire the Company. The
complaint seeks declaratory and injunctive relief, a constructive trust upon any benefits
improperly received as a result of the alleged wrongful conduct and breach of any duty owed to the
holders of Shares, and costs, including attorneys and expert fees. This lawsuit was dismissed
without prejudice on December 15, 2009.
On May 7, 2009, Kamwai Fred Chan filed a lawsuit in the Court of Chancery of the State of
Delaware on behalf of himself and all other similarly situated stockholders of the Company. The
complaint names the members of the Board and the Company as defendants. The complaint asserts a
claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to
the Companys January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to
replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and
actions in response to Broadcoms announcement of its proposal to acquire the Company. The
complaint seeks declaratory and injunctive relief, compensatory damages, interest and costs,
including attorneys and expert fees.
On May 11, 2009, the Court of Chancery of the State of Delaware granted plaintiff Reid
Middletons motion to expedite proceedings and set a trial date in the three foregoing Delaware
lawsuits beginning on July 8, 2009. On July 6, 2009, the Court of Chancery continued the July 8,
2009 trial date indefinitely. On December 3, 2009, the plaintiffs attorneys filed an application
for an award of attorneys fees and expenses. The Court rejected the plaintiffs request for
attorneys fees on December 18, 2009.
On May 11, 2009, Pipefitters Local No. 636 Defined Benefit Plan filed a lawsuit in the Court
of Chancery of the State of Delaware on behalf of itself and all other similarly situated
stockholders of the Company and derivatively on behalf of the Company. The original complaint named
the members of the Companys Board as defendants and the Company as a nominal defendant. The
complaint asserted a claim for breach of fiduciary duty on behalf of a putative class of holders of
Shares relating to the Companys January 2009 amendments to its Bylaws, adoption of a new
shareholder rights plan to replace its expiring rights plan, amendments to its Key Employee
Retention Agreements, and actions in response to Broadcoms announcement of its proposal to acquire
the Company. The original complaint also asserted a derivative claim for breach of fiduciary duty
based on the same actions. The original complaint sought declaratory and injunctive relief,
including mandatory injunctive relief, and costs, including attorneys and expert fees.
On May 12, 2009, Norfolk County Retirement System filed a lawsuit in the Court of Chancery of
the State of Delaware on behalf of itself and all other similarly situated stockholders of the
Company. The original complaint named the members of the Companys Board and the Company as
defendants. The original complaint asserted a claim for breach of fiduciary duty on behalf of a
putative class of holders of Shares relating to the Companys January 2009 amendments to its
Bylaws, adoption of a new shareholder rights plan to replace its expiring rights plan, and
amendments to its Key Employee Retention Agreements, and actions in response to Broadcoms
announcement of its proposal to acquire the Company. The original complaint sought declaratory and
injunctive relief, compensatory damages, interest and costs, including attorneys and expert fees.
On September 17, 2009, Reid Middleton, Pipefitters Local No. 636 Defined Benefit Plan and
Norfolk County Retirement System (together the Plaintiffs) filed a Verified Amended Class Action
and Derivative Complaint in the Court of Chancery of the State of Delaware. The amended complaint
is brought on behalf of Plaintiffs and all other similarly situated stockholders of the Company
and, alternatively, derivatively on behalf of the Company. The complaint names the members of the
Board as defendants and the Company as a nominal defendant. The complaint asserts claims for breach
of fiduciary duty on behalf of a putative class of holders of Shares and, alternatively, a
derivative claim for devaluation of the Company stemming from the Companys January 2009 amendments
to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and
amendments to its Key Employee Retention Agreements, and actions in response to Broadcoms
announcement of its proposal to acquire the Company. The complaint seeks declaratory relief,
compensatory damages, interest and costs, including attorneys and expert fees. On October 13,
2009, the defendants filed an answer to the amended complaint.
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On September 14, 2009, Broadcom Corporation filed a patent infringement lawsuit against the
Company in the United States District Court, in the Central District of California. The suit
alleges that the Company is infringing 10 Broadcom patents covering certain data and storage
networking technologies. The complaint seeks declaratory and injunctive relief, monetary damages,
and interest and costs, including attorneys and expert fees. On November 4, 2009, the Company
filed its answer and affirmative defenses to the patent infringement complaint alleging that it
believes that the Broadcom patents at issue are invalid or not infringed, or both. In addition,
the Company asserted counterclaims for declaratory judgment of invalidity and non-infringement
against each of the Broadcom patents at issue, and seeks award of attorneys fees, costs, and
expenses. On January 11, 2010, the Court set a trial date of September 20, 2011.
On November 9, 2009, the Company filed a lawsuit against Broadcom Corporation alleging that
Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws, as well as
made defamatory statements and engaged in acts of unfair competition. The complaint seeks actual
and punitive damages, attorneys fees and costs, and injunctive relief against Broadcom. On
January 4, 2010, the Company filed an amended complaint. The amended complaint alleges that
Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws and made
defamatory statements. The amended complaint seeks actual and punitive damages, attorneys fees
and costs, and injunctive relief. Broadcoms response to the amended complaint is due to be filed
on February 4, 2010.
In addition to the ongoing litigation discussed above, the Company is involved in various
claims and legal actions arising in the ordinary course of business. In the opinion of management,
the ultimate disposition of the open matters will not have a material adverse effect on the
Companys consolidated financial position, results of operations or liquidity.
Broadcom Unsolicited Takeover Proposal
Broadcom Corporation initiated an unsolicited takeover proposal of $9.25 per share to purchase
all the common shares of the Company on May 5, 2009. On June 30, 2009, Broadcom Corporation
increased its offer price to $11.00 per share and extended the expiration of the tender offer
period to July 14, 2009. On July 9, 2009, Broadcom Corporation announced it would cease further
efforts to acquire the Company. On July 14, 2009, Broadcom Corporations tender offer expired
without further action.
Other Commitments and Contingencies
The Company has approximately $32.5 million of unrecognized tax benefits as of December 27,
2009 for which a reasonably reliable estimate of the period of payment cannot be made.
The Company has entered into various agreements for purchases of inventory. As of December 27,
2009, the Companys purchase obligation associated primarily with inventory was approximately $38.1
million.
In addition, the Company provides limited indemnification in selected circumstances within its
various customer contracts whereby the Company indemnifies the parties to whom it sells its
products with respect to the Companys product infringement of certain intellectual property, and
in some limited cases against bodily injury or damage to real or tangible personal property caused
by a defective Company product. It is not possible to predict the maximum potential amount of
future payments under these or similar agreements, due to the conditional nature of the Companys
obligations and the unique facts and circumstances involved in each particular agreement. As of
December 27, 2009, the Company has not incurred any significant costs related to indemnification of
its customers.
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9. Treasury Stock
In early August 2008, the Companys Board of Directors authorized a plan to repurchase up to
$100.0 million of its outstanding common stock. In April 2009, upon receipt of an unsolicited
acquisition proposal and related tender offer of Broadcom Corporation to acquire the Company, the
Companys Board of Directors elected to temporarily suspend any activity under the share repurchase
plan. In light of Broadcoms announcement of its decision to allow its tender offer to expire on
July 14, 2009, Emulexs Board of Directors elected to reactivate the $100.0 million share
repurchase plan effective July 15, 2009. During the six months ended December 27, 2009, the
Company has repurchased 2.0 million shares of its common stock for an aggregate purchase price of
approximately $18.2 million or an average of $9.12 per share under this plan. The Company may
repurchase shares from time-to-time in open market purchases or privately negotiated transactions.
The share repurchases will be financed by available cash balances and cash from operations. The
Companys Board of Directors has not set an expiration date for the plan.
10. Stock-Based Compensation
As of December 27, 2009, the Company had three stock-based plans for employees and directors
that are open for future awards, the 2005 Equity Incentive Plan (Equity Incentive Plan), the 1997
Stock Award Plan for Non-Employee Directors (Director Plan), and the Emulex Corporation Employee
Stock Purchase Plan (Purchase Plan). In addition, the Company had eight stock-based plans (All
Other Plans), including six plans assumed in connection with prior acquisitions, each of which is
closed for future grants but has options outstanding. Available for future awards are 4,633,638
shares under the Equity Incentive Plan, 271,000 shares under the Director Plan, and 1,008,061
shares under the Purchase Plan.
Aggregate amounts recognized in the condensed consolidated financial statements with respect
to these plans are as follows:
Three Months | Three Months | Six Months | Six Months | |||||||||||||
Ended | Ended | Ended | Ended | |||||||||||||
December 27, | December 28, | December 27, | December 28, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(in thousands) | ||||||||||||||||
Total cost of
stock-based payment
plans during the
period |
$ | 3,590 | $ | 5,735 | $ | 8,493 | $ | 12,518 | ||||||||
Amounts capitalized
in inventory during
the period |
(83 | ) | (165 | ) | (203 | ) | (344 | ) | ||||||||
Amounts recognized
in income for
amounts previously
capitalized in
inventory |
120 | 179 | 274 | 345 | ||||||||||||
Amounts charged
against income,
before income tax
benefit |
$ | 3,627 | $ | 5,749 | $ | 8,564 | $ | 12,519 | ||||||||
Amount of related
income tax benefit
recognized in
income, excluding
tax impact of stock
option exchange
program (see Note
11) |
$ | 1,438 | $ | 1,574 | $ | 3,067 | $ | 3,490 | ||||||||
The fair value of each stock option award under the Equity Incentive Plan and the Director
Plan and purchase under the Purchase Plan is estimated on the date of grant using the Black-Scholes
option-pricing model based on the market price of the underlying common stock on the date of grant,
expected term, stock price volatility and expected risk-free interest rates. Expected volatilities
are based on methodologies utilizing equal weighting involving both historical periods equal to the
expected term and implied volatilities based on traded options to buy the Companys shares. The
fair value of each unvested stock award is determined based on the closing price of the Companys
common stock on the grant date.
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The assumptions utilized to compute the fair value of stock option grants under the Equity
Incentive Plan and the Director Plan for the three and six months ended December 27, 2009 and
December 28, 2008 were:
Three Months Ended | Six Months Ended | |||||||
December 27, | December 28, | December 27, | December 28, | |||||
2009 | 2008 | 2009 | 2008 | |||||
Expected volatility |
46% 49% | 50% 51% | 46% 49% | 42% 51% | ||||
Weighted average expected volatility |
48% | 51% | 47% | 43% | ||||
Expected dividends |
| | | | ||||
Expected term (in years) |
2.97 4.97 | 2.97 4.97 | 2.97 4.97 | 2.97 4.97 | ||||
Weighted average expected term
(in years) |
3.81 | 3.81 | 3.81 | 3.81 | ||||
Risk-free rate |
1.49% 2.50% | 1.12% 1.50% | 1.49% 2.50% | 1.12% 3.02% |
The assumptions utilized to compute the fair value of the compensatory element related to the
shares to be purchased under the Purchase Plan for the three and six months ended December 27, 2009
and December 28, 2008 were:
Three Months Ended | Six Months Ended | |||||||||||||||
December 27, | December 28, | December 27, | December 28, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Expected volatility |
43 | % | 49 | % | 43 | % | 49 | % | ||||||||
Expected dividends |
| | | | ||||||||||||
Expected term (in years) |
0.49 | 0.5 | 0.49 | 0.5 | ||||||||||||
Risk-free rate |
0.17 | % | 1.13 | % | 0.17 | % | 1.13 | % |
A summary of option activity under the plans for the six months ended December 27, 2009 is as
follows:
Weighted | ||||||||||||||||
Average | ||||||||||||||||
Weighted | Remaining | Aggregate | ||||||||||||||
Average | Contractual | Intrinsic | ||||||||||||||
Options | Exercise Price | Term | Value | |||||||||||||
(in years) | (in millions) | |||||||||||||||
Options outstanding at June 28, 2009 |
12,180,404 | $ | 21.68 | 3.10 | $ | 2.0 | ||||||||||
Options granted |
423,000 | $ | 9.81 | |||||||||||||
Options exercised |
(26,973 | ) | $ | 2.73 | ||||||||||||
Options canceled |
(4,159,933 | ) | $ | 22.83 | ||||||||||||
Options forfeited |
(495,744 | ) | $ | 16.98 | ||||||||||||
Options outstanding at December 27, 2009 |
7,920,754 | $ | 20.81 | 3.04 | $ | 2.7 | ||||||||||
Options vested and expected to vest at December 27, 2009 |
7,853,859 | $ | 20.89 | 3.02 | $ | 2.6 | ||||||||||
Options exercisable at December 27, 2009 |
7,102,489 | $ | 21.79 | 2.82 | $ | 2.1 | ||||||||||
A summary of unvested stock awards activity for the six months ended December 27, 2009 is as
follows:
Weighted | ||||||||
Average Grant | ||||||||
Number of | Date Fair | |||||||
Awards | Value | |||||||
Awards outstanding and unvested at June 28, 2009 |
2,721,606 | $ | 12.85 | |||||
Awards granted |
1,521,008 | $ | 8.66 | |||||
Awards vested |
(988,460 | ) | $ | 15.48 | ||||
Awards forfeited |
(161,618 | ) | $ | 14.15 | ||||
Awards outstanding and unvested at December 27, 2009 |
3,092,536 | $ | 9.88 | |||||
As of December 27, 2009, there was approximately $19.4 million of total unrecognized
compensation cost related to nonvested share-based compensation arrangements granted under the
plans. That cost is expected to be recognized over a weighted-average period of approximately 1.4
years.
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The weighted average grant date fair value of options granted during the six months ended
December 27, 2009 and December 28, 2008 was approximately $3.69 per share and $4.15 per share,
respectively. The weighted average grant date fair value of unvested stock awards granted during
the six months ended December 27, 2009 and December 28, 2008 was approximately $8.66 per share and
$10.36 per share, respectively. The total intrinsic value of stock options exercised was
approximately $0.2 million and $1.1 million for the six months ended December 27, 2009 and December
28, 2008, respectively. The total fair value of unvested stock awards that vested during the six
months ended December 27, 2009 and December 28, 2008 was approximately $9.8 million and $6.9
million, respectively. Cash received from stock option exercises under stock-based plans and shares
purchased under the Purchase Plan was approximately $2.7 million for the six months ended December
27, 2009 and approximately $3.8 million for the six months ended December 28, 2008. The actual tax
benefit realized for tax deductions from option exercises was approximately $3.8 million and $3.0
million for the six months ended December 27, 2009 and December 28, 2008, respectively.
On July 14, 2009, the Company completed the option exchange program approved by shareholders
at Emulexs Annual Shareholders Meeting on November 19, 2008. There were 3,925,263 options
cancelled in exchange for a total of 225,783 unvested stock units granted to 379 employees. In
connection with the option exchange program, the Company is required to recognize incremental
share-based compensation expense over the remaining vesting period, if the number of shares
underlying the restricted stock units multiplied by the last reported sales price of the Companys
common stock on the grant date of the restricted stock units exceeds the fair value of the eligible
options immediately before their cancellation. The expense related to the option exchange program
was negligible.
As of December 27, 2009, we anticipate that the number of shares authorized under the Equity
Incentive Plan, the Director Plan, the Purchase Plan, and All Other Plans are sufficient to cover
future stock option exercises and shares that will be purchased during the next six month option
period from November 1, 2009 to April 30, 2010 under the Purchase Plan.
11. Income Taxes
The Company recorded an income tax benefit of approximately $12.9 million and an income tax
provision of approximately $4.6 million for the six months ended December 27, 2009 and December 28,
2008, respectively. Due to the current economic climate, forecasting for fiscal 2010 is subject to
significant change and projection of an annual effective tax rate for the year is not appropriate.
Therefore, the quarterly provision was calculated using the year to date actual results for the six
months ended December 27, 2009. The effective tax benefit rate was approximately 10,243% for the
six months ended December 27, 2009 and the effective tax rate was approximately 20% for the six
months ended December 28, 2008. The tax benefit in the current year was primarily generated from
pre-tax losses in the United States, implementation of a stock option exchange program, and savings
from Federal and state research credits. The Companys effective tax rate depends on various
factors, such as tax legislation, the mix of domestic and international pre-tax income, research
and development credits as a percentage of aggregate pre-tax income, and the effectiveness of the
Companys tax planning strategies.
During the six months ended December 27, 2009, income taxes included a benefit of
approximately $4.0 million related to the stock option exchange program. The tax benefit is
primarily due to the recovery of income tax expense previously recognized related to certain
incentive stock options exchanged for restricted stock units as part of the program.
12. Net Income Per Share
In June 2008, the FASB issued authoritative guidance for whether instruments granted in
share-based payment transactions are participating securities prior to vesting and, therefore, need
to be included in the earnings allocation in computing earnings per share (EPS) under the two-class
method described in previously issued guidance for EPS. This guidance is effective for fiscal
years, and interim reporting periods within those fiscal years, beginning after December 15, 2008,
which was the Companys fiscal year beginning June 29, 2009. Upon adoption, EPS data for all
periods presented were adjusted to conform to the authoritative guidance.
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Basic net income per share for the three and six months ended December 27, 2009 and December
28, 2008, was computed by dividing net income attributable to common stockholders by the weighted
average number of common shares outstanding during the period.
Diluted net income per share was computed by dividing net income attributable to common
stockholders by the weighted average number of common shares outstanding during the period
increased to include, if dilutive, the number of additional common shares that would be outstanding
if the dilutive potential common shares from stock-based plans had been issued. The dilutive effect
of outstanding stock options and stock awards is reflected in diluted net income per share by
application of the treasury stock method. The following table sets forth the computation of basic
and diluted net income per share:
Three Months Ended | Six Months Ended | |||||||||||||||
December 27, | December 28, | December 27, | December 28, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(in thousands, except per | (in thousands, except per | |||||||||||||||
share data) | share data) | |||||||||||||||
Numerator Net income |
$ | 8,942 | $ | 10,517 | $ | 12,780 | $ | 18,018 | ||||||||
Less: Undistributed earnings
allocated to participating
securities |
(111 | ) | (272 | ) | (210 | ) | (465 | ) | ||||||||
Undistributed earnings allocated
to common shareholders for basic
net income per share |
$ | 8,831 | $ | 10,245 | $ | 12,570 | $ | 17,553 | ||||||||
Undistributed earnings allocated
to common shareholders for
diluted net income per share |
$ | 8,832 | $ | 10,245 | $ | 12,573 | $ | 17,555 | ||||||||
Denominator: |
||||||||||||||||
Denominator for basic net income
per share weighted average shares
outstanding |
79,667 | 80,169 | 79,563 | 80,604 | ||||||||||||
Effect of dilutive securities: |
||||||||||||||||
Dilutive options outstanding,
unvested stock units and ESPP |
1,067 | 251 | 942 | 451 | ||||||||||||
Denominator for diluted net income
per share adjusted weighted
average shares outstanding |
80,734 | 80,420 | 80,505 | 81,055 | ||||||||||||
Basic net income per share |
$ | 0.11 | $ | 0.13 | $ | 0.16 | $ | 0.22 | ||||||||
Diluted net income per share |
$ | 0.11 | $ | 0.13 | $ | 0.16 | $ | 0.22 | ||||||||
Antidilutive options and unvested
stock excluded from the
computations |
8,338 | 15,787 | 8,987 | 15,292 | ||||||||||||
Average market price of common stock |
$ | 10.55 | $ | 7.86 | $ | 10.09 | $ | 10.02 | ||||||||
The antidilutive stock options and unvested stock were excluded from the computation of
diluted net income per share due to the assumed proceeds from the awards exercise or vesting being
greater than the average market price of the common shares for the periods presented.
18
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
Certain statements contained in this Form 10-Q may constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995. We may also make
forward-looking statements in other reports filed with the Securities and Exchange Commission, in
materials delivered to stockholders and in press releases. In addition, our representatives may
from time to time make oral forward-looking statements. Forward-looking statements provide current
expectations of future events based on certain assumptions and include any statement that does not
directly relate to any historical or current fact. Words such as anticipates, in the opinion,
believes, intends, expects, may, will, should, could, plans, forecasts,
estimates, predicts, projects, potential, continue, and similar expressions may be
intended to identify forward-looking statements.
Actual future results could differ materially from those described in the forward-looking
statements as a result of a variety of factors, including those discussed in Managements
Discussion and Analysis of Financial Condition and Results of Operations set forth below, and, in
particular, those in the section entitled Risk Factors in Part II, Item 1A of this Form 10-Q
included elsewhere herein. We expressly disclaim any obligation or undertaking to release publicly
any updates or changes to these forward-looking statements that may be made to reflect any future
events or circumstances. We wish to caution readers that a number of important factors could cause
actual results to differ materially from those in the forward-looking statements. The fact that the
uncertainty of the economy generally, and the technology and storage segments specifically, have
been in a state of uncertainty makes it difficult to determine if past experience is a good guide
to the future and makes it impossible to determine if markets will grow or shrink in the short
term. The recent economic downturn and the resulting economic uncertainty for our customers and the
storage networking market as a whole has resulted in a decrease in information technology spending
that has and could continue to adversely affect our revenues and results of operations.
Furthermore, the effect of any actual or potential unsolicited offers to acquire us may have an
adverse effect on our operations. As a result of this uncertainty, we are unable to predict with
any accuracy what future results might be. Other factors affecting these forward-looking statements
include, but are not limited to, the following: slower than expected growth of the storage
networking market or the failure of our Original Equipment Manufacturer (OEM) customers to
successfully incorporate our products into their systems; our dependence on a limited number of
customers and the effects of the loss of, or decrease or delays in orders by, any such customers,
or the failure of such customers to make payments; the emergence of new or stronger competitors as
a result of consolidation movements in the market; the timing and market acceptance of our or our
OEM customers new or enhanced products; the variability in the level of our backlog and the
variable and seasonal procurement patterns of our customers; impairment charges, including but not
limited to goodwill, intangible assets, and equity investments recorded under the cost method;
changes in tax rates or legislation; the effects of acquisitions; the effects of terrorist
activities, natural disasters and any resulting political or economic instability; the highly
competitive nature of the markets for our products as well as pricing pressures that may result
from such competitive conditions; the effect of rapid migration of customers towards newer, lower
cost product platforms; possible transitions from board or box level to application specific
computer chip solutions for selected applications; a shift in unit product mix from higher-end to
lower-end or mezzanine card products; a decrease in the average unit selling prices or an increase
in the manufactured cost of our products; delays in product development; our reliance on
third-party suppliers and subcontractors for components and assembly; any inadequacy of our
intellectual property protection or the potential for third-party claims of infringement; our
ability to attract and retain key technical personnel; our ability to benefit from our research and
development activities; our dependence on international sales and internationally produced
products; changes in accounting standards; and the potential effects of global warming and any
resulting regulatory changes on our business. These and other factors which could cause actual
results to differ materially from those in the forward-looking statements are discussed elsewhere
in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials
incorporated therein by reference.
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Executive Overview
Emulex creates enterprise-class products that connect storage, servers and networks. We are a
leading supplier of a broad range of advanced storage networking convergence solutions. The worlds
leading server and storage providers depend on our products to help build high performance, highly
reliable, and scalable storage networking solutions. Our products and technologies leverage
flexible multi protocol architectures that extend from deep within the storage array to the server
edge of storage area networks (SANs).
Our Company operates within a single business segment that has two market focused product
lines Host Server Products (HSP) and Embedded Storage Products (ESP). HSP includes both Fibre
Channel based connectivity products and Enhanced Ethernet based products that support Internet
Protocol (IP) and storage networking, including Transmission Control Protocol (TCP)/IP, Internet
Small Computer System Interface (iSCSI), Network Attached Storage (NAS) and Fibre Channel over
Ethernet (FCoE). Our Fibre Channel based products include LightPulse® HBAs, custom form factor
solutions for OEM blade servers and application specific integrated circuits (ASICs). These
products enable servers to efficiently connect to SANs by offloading data communication processing
tasks from the server as information is delivered and sent to the storage network. Our Enhanced
Ethernet based products include OneConnect Universal Converged Network Adapters (UCNAs) that enable
network convergence.
ESP includes our InSpeed, FibreSpy®, IOC solutions, switch-on-a-chip (SOC) and bridge and
router products. Embedded storage switches, bridges, routers, and IOCs are deployed inside storage
arrays, tape libraries, and other storage appliances, connect storage controllers to storage
capacity delivering improved performance, reliability, and storage connectivity.
Our Other category primarily consists of contract engineering services, legacy and other
products.
We rely almost exclusively on OEMs and sales through distribution channels for our revenue.
Our OEM customers include the worlds leading server and storage providers, including Dell Inc.
(Dell), EMC Corporation (EMC), Fujitsu Ltd. (Fujitsu), Groupe Bull (Bull), Hewlett-Packard Company
(Hewlett-Packard), Hitachi Data Systems (HDS), Hitachi Limited (Hitachi), International Business
Machines Corporation (IBM), LSI Corporation (LSI), NEC Corporation (NEC), Network Appliance, Inc.
(NetApp), Quantum Corporation (Quantum), Sun Microsystems, Inc. (Sun), Unisys Corporation (Unisys),
and Xyratex Ltd. (Xyratex). Our distribution partners include Arrow ECS Denmark A/S (Arrow), Avnet,
Inc. (Avnet), Bell Microproducts, Ltd. (Bell), Info X Distribution, LLC (Info X), Ingram Micro Inc.
(Ingram Micro), Macnica Networks Corporation (Macnica), Netmarks Inc. (Netmarks), Tech Data
Corporation (Tech Data), and Tokyo Electron Device Ltd. (TED). The market for storage networking
infrastructure solutions is concentrated among large OEMs, and as such, a significant portion of
our revenues are generated from sales to a limited number of customers.
The recent economic downturn and related economic uncertainty for our customers and the
storage networking market as a whole has resulted in a downturn in information technology spending
that has and could continue to adversely affect our revenues and results of operations. As a result
of this uncertainty, we plan to continue to closely manage our controllable expenses while
investing in research and development, sales and marketing, capital equipment, and facilities in
order to achieve our growth and market leadership goals. As of December 27, 2009, we had a total of
765 employees.
Our corporate headquarters are located at 3333 Susan Street, Costa Mesa, California 92626. Our
periodic and current reports filed with, or furnished to, the Securities and Exchange Commission
pursuant to the requirements of the Securities and Exchange Act of 1934 are available free of
charge through our website (www.emulex.com) as soon as reasonably practicable after such reports
are electronically filed with, or furnished to, the Securities and Exchange Commission. References
contained herein to Emulex, the Company, the Registrant, we, our, and us refer to
Emulex Corporation and its subsidiaries.
20
Table of Contents
Global Initiatives
As part of our global initiatives, we created an Irish subsidiary to expand our international
operations by providing local customer service and support to our customers outside of the United
States in the fourth quarter of fiscal 2008. In addition, Emulex granted an intellectual property
license and entered into a research and development cost sharing agreement with a newly formed
subsidiary in the Isle of Man. The terms of the license require that the subsidiary make
prepayments of expected royalties to a U.S. subsidiary, the first of which was paid before the end
of fiscal 2008 in the amount of approximately $131.0 million, for expected royalties relating to
fiscal 2009 through 2015. These global initiatives are expected to significantly reduce our
effective tax rate beginning with fiscal 2010.
Our cash balances and investments are held in numerous locations throughout the world. The
cash and investments held outside of the U.S. are expected to increase, primarily in our Isle of
Man and Ireland subsidiaries. Substantially all of the amounts held outside of the U.S. will be
available for repatriation at any time, but under current law, repatriated funds would be subject
to U.S. federal income taxes, less applicable foreign tax credits.
Results of Operations
The following discussion and analysis should be read in conjunction with the condensed
consolidated financial statements included elsewhere herein.
Percentage of Net Revenues | Percentage of Net Revenues | |||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
December 27, | December 28, | December 27, | December 28, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net revenues |
100 | % | 100 | % | 100 | % | 100 | % | ||||||||
Cost of sales |
38 | 39 | 39 | 38 | ||||||||||||
Gross profit |
62 | 61 | 61 | 62 | ||||||||||||
Operating expenses: |
||||||||||||||||
Engineering and
development |
29 | 28 | 33 | 30 | ||||||||||||
Selling and marketing |
15 | 12 | 15 | 13 | ||||||||||||
General and
administrative |
11 | 9 | 12 | 8 | ||||||||||||
Amortization of
other intangible
assets |
2 | 2 | 2 | 2 | ||||||||||||
Total operating
expenses |
57 | 51 | 62 | 53 | ||||||||||||
Operating income (loss) |
5 | 10 | (1 | ) | 9 | |||||||||||
Nonoperating (expense)
income, net: |
||||||||||||||||
Interest income |
| 1 | | 1 | ||||||||||||
Interest expense |
| | | | ||||||||||||
Other (expense)
income, net |
| | | | ||||||||||||
Total
nonoperating
(expense) income,
net |
| 1 | | 1 | ||||||||||||
Income (loss) before
income taxes |
5 | 11 | (1 | ) | 10 | |||||||||||
Income tax (benefit)
provision |
(3 | ) | 1 | (7 | ) | 2 | ||||||||||
Net income |
8 | % | 10 | % | 6 | % | 8 | % | ||||||||
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Three months ended December 27, 2009, compared to three months ended December 28, 2008
Net Revenues. Net revenues for the second quarter of fiscal 2010 ended December 27, 2009, was
essentially unchanged compared to the same quarter of fiscal 2009 ended December 28, 2008.
Net Revenues by Product Line
The following chart details our net revenues by product line for the three months ended
December 27, 2009 and December 28, 2008:
Net Revenues by Product Line | ||||||||||||||||||||||||
Three Months | Three Months | |||||||||||||||||||||||
Ended | Percentage | Ended | Percentage | |||||||||||||||||||||
December 27, | of Net | December 28, | of Net | Increase/ | Percentage | |||||||||||||||||||
(in thousands) | 2009 | Revenues | 2008 | Revenues | (Decrease) | Change | ||||||||||||||||||
Host Server Products |
$ | 81,923 | 76 | % | $ | 81,063 | 75 | % | $ | 860 | 1 | % | ||||||||||||
Embedded Storage Products |
26,284 | 24 | % | 27,454 | 25 | % | (1,170 | ) | (4 | )% | ||||||||||||||
Other |
83 | | 144 | | (61 | ) | (42 | )% | ||||||||||||||||
Total net revenues |
$ | 108,290 | 100 | % | $ | 108,661 | 100 | % | $ | (371 | ) | | % | |||||||||||
HSP consists of HBAs, mezzanine cards, I/O ASICs, and UCNAs. For the three months ended
December 27, 2009, our Fibre Channel based products still accounted for the vast majority of our
HSP revenues. The increase in our HSP net revenue for the three months ended December 27, 2009
compared to the three months ended December 28, 2008 was mainly due to an increase of approximately
16% in units shipped partially offset by a decrease of approximately 13% in average selling price.
ESP primarily consists of our InSpeed®, FibreSpy®, input/output controller solutions, and
bridge and router products. The decrease in our ESP net revenue for the three months ended December
27, 2009 compared to the three months ended December 28, 2008 was primarily due to a decrease in
average selling price of approximately 14% partially offset by an increase in units shipped of
approximately 12%.
Our Other category primarily consists of contract engineering services, legacy and other
products.
Net Revenues by Major Customers
In addition to direct sales, some of our larger OEM customers purchase or market products
indirectly through distributors, resellers or other third parties. If these indirect sales are
purchases of customer-specific models, we are able to track these sales. However, if these indirect
sales are purchases of our standard models, we are not able to distinguish them by OEM customer.
Customers whose direct net revenues, or total direct and indirect net revenues (including
customer-specific models purchased or marketed indirectly through distributors, resellers and other
third parties), exceeded 10% of our net revenues were as follows:
Net Revenues by Major Customers | ||||||||||||||||
Direct Revenues | Total Direct and Indirect Revenues (2) | |||||||||||||||
Three Months | Three Months | Three Months | Three Months | |||||||||||||
Ended | Ended | Ended | Ended | |||||||||||||
December 27, | December 28, | December 27, | December 28, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net revenue
percentage (1): |
||||||||||||||||
OEM: |
||||||||||||||||
EMC |
| | 12 | % | 14 | % | ||||||||||
Hewlett-Packard |
13 | % | 18 | % | 14 | % | 18 | % | ||||||||
IBM |
23 | % | 23 | % | 33 | % | 30 | % |
(1) | Amounts less than 10% are not presented. |
|
(2) | Customer-specific models purchased or marketed indirectly through distributors, resellers,
and other third parties are included with the OEMs revenues in these columns rather than as
revenue for the distributors, resellers or other third parties. |
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Direct sales to our top five customers accounted for approximately 58% of total net revenues
for the three months ended December 27, 2009, compared to approximately 63% for the three months
ended December 28, 2008. Our net revenues from customers can be significantly impacted by changes
to our customers business and their business models. Direct and indirect sales to our top five
customers accounted for approximately 72% of total net revenues for the three months ended December
27, 2009 compared to approximately 75% for the three months ended December 28, 2008. Our net
revenues from customers can be significantly impacted by changes to our customers business and
their business models.
Net Revenues by Sales Channel
Net revenues by sales channel were as follows:
Net Revenues by Sales Channel | ||||||||||||||||||||||||
Three Months | Three Months | |||||||||||||||||||||||
Ended | Percentage | Ended | Percentage | |||||||||||||||||||||
December 27, | of Net | December 28, | of Net | Increase/ | Percentage | |||||||||||||||||||
(in thousands) | 2009 | Revenues | 2008 | Revenues | (Decrease) | Change | ||||||||||||||||||
OEM |
$ | 91,194 | 84 | % | $ | 87,410 | 80 | % | $ | 3,784 | 4 | % | ||||||||||||
Distribution |
16,992 | 16 | % | 21,173 | 20 | % | (4,181 | ) | (20 | )% | ||||||||||||||
Other |
104 | | 78 | | 26 | 33 | % | |||||||||||||||||
Total net revenues |
$ | 108,290 | 100 | % | $ | 108,661 | 100 | % | $ | (371 | ) | | % | |||||||||||
The increase in OEM net revenues as a percentage of total net revenues was mainly due to end
users migrating from purchasing our products through the distribution channel toward purchasing our
products through OEM server manufacturers. We believe that our net revenues are being generated
primarily as a result of product certifications and qualifications with our OEM customers, which
take products directly and indirectly through distribution and contract manufacturers. We view
product certifications and qualifications as an important indicator of future revenue opportunities
and growth for the Company. However, product certifications and qualifications do not necessarily
ensure continued market acceptance of our products by our OEM customers. It is also very difficult
to determine the future impact, if any, of product certifications and qualifications on our
revenues.
Net Revenues by Geographic Territory
Our net revenues by geographic territory based on billed-to location were as follows:
Net Revenues by Geographic Territory | ||||||||||||||||||||||||
Three Months | Three Months | |||||||||||||||||||||||
Ended | Percentage | Ended | Percentage | |||||||||||||||||||||
December 27, | of Net | December 28, | of Net | Increase/ | Percentage | |||||||||||||||||||
(in thousands) | 2009 | Revenues | 2008 | Revenues | (Decrease) | Change | ||||||||||||||||||
United States |
$ | 33,324 | 31 | % | $ | 41,499 | 38 | % | $ | (8,175 | ) | (20 | )% | |||||||||||
Asia Pacific |
40,172 | 37 | % | 28,084 | 26 | % | 12,088 | 43 | % | |||||||||||||||
Europe, Middle
East, Africa and
rest of the world |
34,794 | 32 | % | 39,078 | 36 | % | (4,284 | ) | (11 | )% | ||||||||||||||
Total net revenues |
$ | 108,290 | 100 | % | $ | 108,661 | 100 | % | $ | (371 | ) | | % | |||||||||||
We believe the decrease in United States net revenues and increase in Asia Pacific net
revenues as a percentage of total net revenues for the three months ended December 27, 2009
compared to the three months ended December 28, 2008 was primarily due to our OEM customers
migrating towards using contract manufacturers located internationally, predominantly in Asia
Pacific. However, as we sell to OEMs and distributors who ultimately resell our products to their
customers, the geographic mix of our net revenues may not be reflective of the geographic mix of
end-user demand or installations.
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Gross Profit. Gross profit consists of net revenues less cost of sales. Our gross profit for
the three months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
Gross Profit | ||||||||||||||||||||
Three Months Ended | Percentage of | Three Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$66,784 |
62 | % | $ | 65,985 | 61 | % | $ | 799 | 1 | % |
Cost of sales includes the cost of producing, supporting, and managing our supply of quality
finished products. Cost of sales also included approximately $4.7 million of amortization of
technology intangible assets for both the three months ended December 27, 2009 and December 28,
2008. Approximately $0.3 million and $0.4 million of share-based compensation expense was included
in cost of sales for the three months ended December 27, 2009 and December 28, 2008, respectively.
Gross margin increased during the three months ended December 27, 2009 primarily due to the gain in
efficiencies resulting from higher manufacturing volume that was partially offset by a decline in
average sales price. Even though gross margin increased in the three months ended December 27, 2009
compared to the three months ended December 28, 2008, we anticipate gross margin will trend
downward over time as faster growing, lower gross margin products become a bigger portion of our
business.
Engineering and Development. Engineering and development expenses consisted primarily of
salaries and related expenses for personnel engaged in the design, development, and technical
support of our products. These expenses included third-party fees paid to consultants, prototype
development expenses, and computer service costs related to supporting computer tools used in the
design process. Expenses for the three months ended December 27, 2009 and December 28, 2008 were as
follows (in thousands):
Engineering and Development | ||||||||||||||||||||
Three Months Ended | Percentage of | Three Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$31,680 |
29 | % | $ | 31,101 | 28 | % | $ | 579 | 1 | % |
Engineering and development expenses for the three months ended December 27, 2009 compared to
the three months ended December 28, 2008 increased approximately $0.6 million, or 2%. Approximately
$1.2 million and $2.6 million of share-based compensation expense was included in engineering and
development costs for the three months ended December 27, 2009 and December 28, 2008, respectively.
As a result of organizational changes in fiscal 2009, engineering and development headcount
decreased to 450 at December 27, 2009 from 467 at December 28, 2008. The decrease in headcount
resulted in a net decrease of approximately $0.6 million in salary and related expenses as compared
to the same period in fiscal 2009, offset by an increase in performance based compensation of
approximately $1.0 million. Costs associated with new product development increased by
approximately $3.2 million compared to the same period in fiscal 2009, partially offset by a
decrease in technology spending of approximately $0.8 million, a decrease in depreciation expense
of approximately $0.5 million, and a decrease in supplies and equipment expense of approximately
$0.3 million.
Selling and Marketing. Selling and marketing expenses consisted primarily of salaries,
commissions, and related expenses for personnel engaged in the marketing and sales of our products,
as well as trade shows, product literature, promotional support costs, and other advertising
related costs. Expenses for the three months ended December 27, 2009 and December 28, 2008 were as
follows (in thousands):
Selling and Marketing | ||||||||||||||||||||
Three Months Ended | Percentage of | Three Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$15,760 |
15 | % | $ | 13,270 | 12 | % | $ | 2,490 | 3 | % |
Selling and marketing expenses for the three months ended December 27, 2009 compared to the
three months ended December 28, 2008 increased approximately $2.5 million, or 19%. Approximately
$0.9 million and $1.0 million of share-based compensation expense was included in selling and
marketing costs for the three months ended December 27, 2009 and December 28, 2008, respectively.
Selling and marketing headcount decreased to 121 at December 27, 2009 from 135 at December 28,
2008. The decrease in headcount resulted in a net decrease of approximately $0.7 million in salary
and related expenses as compared to the same period in fiscal 2009, offset by an increase in
performance based compensation of approximately $2.4 million. The remaining increase in expenses
during the three months ended December 27, 2009 was partially due to an increase in outside
services of approximately $0.4 million related to new product launches and promotional
sponsorships. We will continue to target advertising, market promotions, and heighten brand
awareness of our new and existing products in an effort to provide overall revenue growth.
24
Table of Contents
General and Administrative. Ongoing general and administrative expenses consisted primarily of
salaries and related expenses for executives, financial accounting support, human resources,
administrative services, professional fees, and other corporate expenses. Expenses for the three
months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
General and Administrative | ||||||||||||||||||||
Three Months Ended | Percentage of | Three Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$11,896 |
11 | % | $ | 9,548 | 9 | % | $ | 2,348 | 2 | % |
General and administrative expenses for the three months ended December 27, 2009 compared to
the three months ended December 28, 2008 increased approximately $2.3 million, or 25%.
Approximately $1.2 million and $1.8 million of share-based compensation expense was included in
general and administrative costs for the three months ended December 27, 2009 and December 28,
2008, respectively. General and administrative headcount decreased to 128 at December 27, 2009 from
139 at December 28, 2008. The decrease in headcount resulted in a net decrease of approximately
$0.8 million in salary and related expenses, offset by an increase in performance based
compensation of approximately $1.0 million. The increase in general and administrative expenses was
primarily due to litigation costs of approximately $4.1 million, partially offset by a decrease in
outside services of approximately $0.7 million, a decrease in supplies and equipment expenses of
approximately $0.3 million, and a decrease in travel and related expenses of approximately $0.2
million.
Amortization of Other Intangible Assets. Amortization of other intangible assets includes the
amortization of intangible assets such as patents, customer relationships, tradenames, and
covenants not-to-compete with estimable lives. Our amortization of expense for the three months
ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
Amortization of Other Intangible Assets | ||||||||||||||||||||
Three Months Ended | Percentage of | Three Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$1,698 |
2 | % | $ | 1,851 | 2 | % | $ | (153 | ) | |
Amortization of other intangible assets for the three months ended December 27, 2009 compared
to the three months ended December 28, 2008 decreased approximately $0.2 million, or 8%. The
decrease was due primarily to a lower unamortized balance of intangibles at the beginning of the
current fiscal quarter.
Nonoperating (Expense) Income, net. Nonoperating (expense) income, net consisted primarily of
interest income, interest expense and other non-operating income and expense items. Our
nonoperating (expense) income, net for the three months ended December 27, 2009 and December 28,
2008 were as follows (in thousands):
Nonoperating (Expense) Income, net | ||||||||||||||||||||
Three Months Ended | Percentage of | Three Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$(41) |
| $ | 1,063 | 1 | % | $ | (1,104 | ) | (1 | )% |
Our nonoperating (expense) income, net, for the three months ended December 27, 2009 compared
to the three months ended December 28, 2008 decreased approximately $1.1 million, or 104%. Included
in nonoperating (expense) income is a foreign currency loss of approximately $0.1 million,
partially offset by interest income. The net decrease was primarily due to a lower balance of
investments combined with lower interest rates on investments.
25
Table of Contents
Income Taxes. Income taxes for the three months ended December 27, 2009 and December 28, 2008
were as follows (in thousands):
Income Taxes | ||||||||||||||||||||
Three Months Ended | Percentage of | Three Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$(3,233) |
(3 | )% | $ | 761 | 1 | % | $ | (3,994 | ) | (4 | )% |
Income taxes for the three months ended December 27, 2009 compared to the three months ended
December 28, 2008 decreased approximately $4.0 million, or 525%. Our effective tax benefit rate was
approximately 57% for the three months ended December 27, 2009 compared to an effective tax rate of
approximately 7% for the three months ended December 28, 2008. The decrease in taxes was due
primarily to a decrease of approximately $8.0 million related to global initiatives and a decrease
of approximately $1.9 million related to share-based compensation, partially offset by an increase
in taxes of approximately $5.9 million related to lower Federal research credits. Tax benefits
from Federal research credits were higher during the three months ended December 28, 2008 due to a
retroactive extension of the Federal research credit in October 2008 as part of the Emergency
Economic Stabilization Act of 2008.
Six months ended December 27, 2009, compared to six months ended December 28, 2008
Net Revenues. Net revenues for the six months ended December 27, 2009, decreased by
approximately $26.5 million, or 12%, to approximately $193.8 million compared to approximately
$220.4 million for the six months ended December 28, 2008. We believe the decrease in net
revenues was due primarily to a downturn in information technology spending resulting from the
recent global economic downturn and related economic uncertainty for our customers and the storage
networking market as a whole.
Net Revenues by Product Line
The following chart details our net revenues by product line for the six months ended December
27, 2009 and December 28, 2008:
Net Revenues by Product Line | ||||||||||||||||||||||||
Six Months | Six Months | |||||||||||||||||||||||
Ended | Percentage | Ended | Percentage | |||||||||||||||||||||
December 27, | of Net | December 28, | of Net | Increase/ | Percentage | |||||||||||||||||||
(in thousands) | 2009 | Revenues | 2008 | Revenues | (Decreas) | Change | ||||||||||||||||||
Host Server Products |
$ | 146,068 | 75 | % | $ | 162,266 | 74 | % | $ | (16,198 | ) | (10 | )% | |||||||||||
Embedded Storage Products |
47,558 | 25 | % | 57,818 | 26 | % | (10,260 | ) | (18 | )% | ||||||||||||||
Other |
191 | | 273 | | (82 | ) | (30 | )% | ||||||||||||||||
Total net revenues |
$ | 193,817 | 100 | % | $ | 220,357 | 100 | % | $ | (26,540 | ) | (12 | )% | |||||||||||
For the six months ended December 27, 2009, our Fibre Channel based products still accounted
for the vast majority of our HSP revenues. The decrease in our HSP net revenue for the six months
ended December 27, 2009 compared to the six months ended December 28, 2008 was mainly due to a
decrease in average selling price of approximately 11% partially offset by an increase in units
shipped of approximately 1%.
The decrease in our ESP net revenue for the six months ended December 27, 2009 compared to the
six months ended December 28, 2008 was primarily due to a decrease in units shipped of
approximately 10% combined with a decrease in average selling price of approximately 9%.
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Net Revenues by Major Customers
Customers whose direct net revenues, or total direct and indirect net revenues (including
customer-specific models purchased or marketed indirectly through distributors, resellers and other
third parties), exceeded 10% of our net revenues were as follows:
Net Revenues by Major Customers | ||||||||||||||||
Direct Revenues | Total Direct and Indirect Revenues (2) | |||||||||||||||
Six Months | Six Months | Six Months | Six Months | |||||||||||||
Ended | Ended | Ended | Ended | |||||||||||||
December 27, | December 28, | December 27, | December 28, | |||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net revenue percentage (1): |
||||||||||||||||
OEM: |
||||||||||||||||
EMC |
| | 11 | % | 14 | % | ||||||||||
Hewlett-Packard |
14 | % | 17 | % | 15 | % | 17 | % | ||||||||
IBM |
23 | % | 22 | % | 33 | % | 30 | % |
(1) | Amounts less than 10% are not presented. |
|
(2) | Customer-specific models purchased or marketed indirectly through distributors, resellers,
and other third parties are included with the OEMs revenues in these columns rather than as
revenue for the distributors, resellers or other third parties. |
Direct sales to our top five customers accounted for approximately 59% of total net revenues
for the six months ended December 27, 2009, compared to approximately 62% for the six months ended
December 28, 2008. Direct and indirect sales to our top five customers accounted for approximately
73% of total net revenues for both the six months ended December 27, 2009 and December 28, 2008.
Our net revenues from customers can be significantly impacted by changes to our customers business
and their business models.
Net Revenues by Sales Channel
Net revenues by sales channel were as follows:
Net Revenues by Sales Channel | ||||||||||||||||||||||||
Six Months | Six Months | |||||||||||||||||||||||
Ended | Percentage | Ended | Percentage | |||||||||||||||||||||
December 27, | of Net | December 28, | of Net | Increase/ | Percentage | |||||||||||||||||||
(in thousands) | 2009 | Revenues | 2008 | Revenues | (Decrease) | Change | ||||||||||||||||||
OEM |
$ | 163,481 | 84 | % | $ | 174,921 | 79 | % | $ | (11,440 | ) | (7 | )% | |||||||||||
Distribution |
30,203 | 16 | % | 45,291 | 21 | % | (15,088 | ) | (33 | )% | ||||||||||||||
Other |
133 | | 145 | | (12 | ) | (8 | )% | ||||||||||||||||
Total net revenues |
$ | 193,817 | 100 | % | $ | 220,357 | 100 | % | $ | (26,540 | ) | (12 | )% | |||||||||||
The increase in OEM net revenues as a percentage of total net revenues was mainly due to our
customers migrating from purchasing our products through the distribution channel toward purchasing
our products through OEM server manufacturers.
Net Revenues by Geographic Territory
Our net revenues by geographic territory based on billed-to location were as follows:
Net Revenues by Geographic Territory | ||||||||||||||||||||||||
Six Months | Six Months | |||||||||||||||||||||||
Ended | Percentage | Ended | Percentage | |||||||||||||||||||||
December 27, | of Net | December 28, | of Net | Increase/ | Percentage | |||||||||||||||||||
(in thousands) | 2009 | Revenues | 2008 | Revenues | (Decrease) | Change | ||||||||||||||||||
United States |
$ | 60,090 | 31 | % | $ | 81,298 | 37 | % | $ | (21,208 | ) | (26 | )% | |||||||||||
Asia Pacific |
69,338 | 36 | % | 60,558 | 27 | % | 8,780 | 14 | % | |||||||||||||||
Europe, Middle
East, Africa and
rest of the world |
64,389 | 33 | % | 78,501 | 36 | % | (14,112 | ) | (18 | )% | ||||||||||||||
Total net revenues |
$ | 193,817 | 100 | % | $ | 220,357 | 100 | % | $ | (26,540 | ) | (12 | )% | |||||||||||
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We believe the decrease in United States net revenues and increase in Asia Pacific net
revenues as percentages of total net revenues for the six months ended December 27, 2009 compared
to the six months ended December 28, 2008 was primarily due to our OEM customers migrating towards
using contract manufacturers located internationally, predominantly in Asia Pacific. The overall
decrease in net revenues was due to the global economic slowdown that has resulted in decreased
spending in general and in the technology sector specifically. However, as we sell to OEMs and
distributors who ultimately resell our products to their customers, the geographic mix of our net
revenues may not be reflective of the geographic mix of end-user demand or installations.
Gross Profit. Gross profit consists of net revenues less cost of sales. Our gross profit for
the six months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
Gross Profit | ||||||||||||||||||||
Six Months Ended | Percentage of | Six Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$118,890 |
61 | % | $ | 135,937 | 62 | % | $ | (17,047 | ) | (1 | )% |
Cost of sales includes the cost of producing, supporting, and managing our supply of quality
finished products. Cost of sales also included approximately $9.5 million of amortization of
technology intangible assets for both the six months ended December 27, 2009 and December 28, 2008.
Approximately $0.7 million of share-based compensation expense was included in cost of sales for
both the six months ended December 27, 2009 and December 28, 2008. Gross margin decreased during
the six months ended December 27, 2009 primarily due to the loss of efficiencies resulting from
lower manufacturing volume combined with a decline in average sales prices. We anticipate gross
margin will trend downward over time as faster growing, lower gross margin products become a bigger
portion of our business.
Engineering and Development. Engineering and development expenses consisted primarily of
salaries and related expenses for personnel engaged in the design, development, and technical
support of our products. These expenses included third-party fees paid to consultants, prototype
development expenses, and computer service costs related to supporting computer tools used in the
design process. Expenses for the six months ended December 27, 2009 and December 28, 2008 were as
follows (in thousands):
Engineering and Development | ||||||||||||||||||||
Six Months Ended | Percentage of | Six Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$63,079 |
33 | % | $ | 65,884 | 30 | % | $ | (2,805 | ) | 3 | % |
Engineering and development expenses for the six months ended December 27, 2009 compared to
the six months ended December 28, 2008 decreased approximately $2.8 million, or 4%. Approximately
$3.7 million and $5.8 million of share-based compensation expense was included in engineering and
development costs for the six months ended December 27, 2009 and December 28, 2008, respectively.
As a result of organizational changes in fiscal 2009, engineering and development headcount
decreased to 450 at December 27, 2009 from 467 at December 28, 2008. The decrease in headcount
resulted in a net decrease of approximately $3.7 million in salary and related expenses as compared
to the same period in fiscal 2009, partially offset by an increase in performance based
compensation of approximately $1.0 million. Costs associated with new product development
increased by approximately $4.6 million compared to the same period in the fiscal 2009, partially
offset by a decrease in technology spending of approximately $1.2 million, a decrease depreciation
expense of approximately $0.6 million, and a decrease in supplies and equipment of approximately
$0.7 million. The increase in engineering and development expenses as a percentage of revenues was
primarily due to the relatively fixed amount of such expenses being spread over a lower net revenue
base.
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Selling and Marketing. Selling and marketing expenses consisted primarily of salaries,
commissions, and related expenses for personnel engaged in the marketing and sales of our products,
as well as trade shows, product literature, promotional support costs, and other advertising
related costs. Expenses for the six months ended December 27, 2009 and December 28, 2008 were as
follows (in thousands):
Selling and Marketing | ||||||||||||||||||||
Six Months Ended | Percentage of | Six Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$28,672 |
15 | % | $ | 27,786 | 13 | % | $ | 886 | 2 | % |
Selling and marketing expenses for the six months ended December 27, 2009 compared to the six
months ended December 28, 2008 increased approximately $0.9 million, or 3%. Approximately $1.4
million and $2.0 million of share-based compensation expense was included in selling and marketing
costs for the six months ended December 27, 2009 and December 28, 2008, respectively. Selling and
marketing headcount decreased to 121 at December 27, 2009 from 135 at December 28, 2008. The
decrease in headcount resulted in a net decrease of approximately $1.5 million in salary and
related expenses as compared to the same period in fiscal 2009, offset by an increase in
performance based compensation of approximately $2.9 million. We will continue to target
advertising, market promotions, and heighten brand awareness of our new and existing products in an
effort to provide overall revenue growth. The increase in selling and marketing expenses as a
percentage of revenues was primarily due to the relatively fixed amount of such expenses being
spread over a lower net revenue base.
General and Administrative. Ongoing general and administrative expenses consisted primarily of
salaries and related expenses for executives, financial accounting support, human resources,
administrative services, professional fees, and other corporate expenses. Expenses for the six
months ended December 27, 2009 and December 28, 2008 were as follows (in thousands):
General and Administrative | ||||||||||||||||||||
Six Months Ended | Percentage of | Six Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$24,175 |
12 | % | $ | 18,964 | 8 | % | $ | 5,211 | 4 | % |
General and administrative expenses for the six months ended December 27, 2009 compared to the
six months ended December 28, 2008 increased approximately $5.2 million, or 27%. Approximately $2.8
million and $4.1 million of share-based compensation expense was included in general and
administrative costs for the six months ended December 27, 2009 and December 28, 2008,
respectively. General and administrative headcount decreased to 128 at December 27, 2009 from 139
at December 28, 2008. The decrease in headcount resulted in a net decrease of approximately $0.7
million in salary and related expenses, offset by an increase in performance based compensation of
approximately $1.4 million. The increase in general and administrative expenses was primarily due
to litigation costs of approximately $6.7 million, partially offset by a decrease in outside
services of approximately $1.4 million. The increase in general and administrative expenses as a
percentage of revenues was primarily due to the relatively small increase in expenses being spread
over a lower net revenue base.
Amortization of Other Intangible Assets. Amortization of other intangible assets includes the
amortization of intangible assets such as patents, customer relationships, tradenames, and
covenants not-to-compete with estimable lives. Our amortization of expense for the six months ended
December 27, 2009 and December 28, 2008 were as follows (in thousands):
Amortization of Other Intangible Assets | ||||||||||||||||||||
Six Months Ended | Percentage of | Six Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$3,396 |
2 | % | $ | 3,938 | 2 | % | $ | (542 | ) | |
Amortization of other intangible assets for the six months ended December 27, 2009 compared to
the six months ended December 28, 2008 decreased approximately $0.5 million, or 14%. The decrease
was due primarily to a lower unamortized balance of intangibles at the beginning of the current
fiscal period.
Nonoperating Income, net. Nonoperating income, net consisted primarily of interest income,
interest expense and other non-operating income and expense items. Our nonoperating income, net for
the six months ended December 27, 2009 and December 28, 2009 were as follows (in thousands):
Nonoperating Income, net | ||||||||||||||||||||
Six Months Ended | Percentage of | Six Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$306 |
| $ | 3,234 | 1 | % | $ | (2,928 | ) | (1 | )% |
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Our nonoperating income, net, for the six months ended December 27, 2009 compared to the six
months ended December 28, 2008 decreased approximately $2.9 million, or 91%. The net decrease was
primarily due to a lower balance of investments combined with lower interest rates on investments.
Income Taxes. Income taxes for the six months ended December 27, 2009 and December 28, 2008
were as follows (in thousands):
Income Taxes | ||||||||||||||||||||
Six Months Ended | Percentage of | Six Months Ended | Percentage of | Increase/ | Percentage | |||||||||||||||
December 27, 2009 | Net Revenues | December 28, 2008 | Net Revenues | (Decrease) | Points Change | |||||||||||||||
$(12,906) |
(7 | )% | $ | 4,581 | 2 | % | $ | (17,487 | ) | (9 | )% |
Income taxes for the six months ended December 27, 2009 compared to the six months ended
December 28, 2008 decreased approximately $17.5 million, or 382%. Our effective tax benefit rate
was approximately 10,243% for the six months ended December 27, 2009 compared to an effective tax
rate of approximately 20% for the six months ended December 28, 2008. The decrease in taxes was
due primarily to a decrease of approximately $16.5 million related to global initiatives, a tax
benefit of approximately $4.0 million related to the option exchange program, and a decrease of
approximately $2.1 million related to share-based compensation, partially offset by an increase in
taxes of approximately $5.3 million related to lower Federal research credits. Tax benefits from
Federal research credits were higher during the six months ended December 28, 2008 due to a
retroactive extension of the Federal research credit in October 2008 as part of the Emergency
Economic Stabilization Act of 2008.
Critical Accounting Policies
The preparation of the condensed consolidated financial statements requires estimation and
judgment that affect the reported amounts of net revenues, expenses, assets, and liabilities in
accordance with accounting principles generally accepted in the United States. We base our
estimates on historical experience and on various other assumptions that we believe to be
reasonable under the circumstances and which form the basis for making judgments about the carrying
values of assets and liabilities.
We believe the following are critical accounting policies and require us to make significant
judgments and estimates in the preparation of our condensed consolidated financial statements:
revenue recognition; warranty; allowance for doubtful accounts; intangible assets and other
long-lived assets; inventories; goodwill; income taxes; stock-based compensation; and litigation
costs. Changes in judgments and uncertainties could potentially result in materially different
results under different assumptions and conditions. If these estimates differ significantly from
actual results, the impact to the consolidated financial statements may be material.
Revenue Recognition. We generally recognize revenue at the time of shipment when title and
risk of loss have passed, evidence of an arrangement has been obtained, pricing is fixed or
determinable, and collectibility has been reasonably assured (Basic Revenue Recognition Criteria).
We make certain sales through two tier distribution channels and have various distribution
agreements with selected distributors and Master Value Added Resellers (collectively, the
Distributors). These distribution agreements may be terminated upon written notice by either party.
Additionally, these Distributors are generally given privileges to return a portion of inventory
and to participate in price protection and cooperative marketing programs. Therefore, we recognize
revenue on our standard products sold to our Distributors based on data received from the
Distributors and managements estimates to approximate the point that these products have been
resold by the Distributors. OEM-specific models sold to our Distributors are governed under the
related OEM agreements rather than under these distribution agreements. We recognize revenue at the
time of shipment for OEM specific products shipped to the Distributors when the Basic Revenue
Recognition Criteria have been met. Additionally, we maintain accruals and allowances for price
protection and various other marketing programs. We classify the costs of these incentive programs
based on the benefit received, if applicable, as either a reduction of revenue, a cost of sale, or
an operating expense.
Warranty. We provide a warranty of between one and five years on our products. We record a
provision for estimated warranty related costs at the time of sale based on historical product
return rates and managements estimates of expected future costs to fulfill our warranty
obligations. We evaluate our ongoing warranty obligation on a quarterly basis.
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Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts based upon
historical write-offs as a percentage of net revenues and managements review of outstanding
accounts receivable. Amounts due from customers are charged against the allowance for doubtful
accounts when management believes that collectibility of the amount is unlikely. Although we have
not historically experienced significant losses on accounts receivable, our accounts receivable are
concentrated with a small number of customers. Consequently, any write-off associated with one of
these customers could have a significant impact on our allowance for doubtful accounts and results
of operations.
Intangible Assets and Other Long-Lived Assets. Intangible assets resulting from acquisitions
are carried at cost less accumulated amortization and impairment charges, if any. For assets with
determinable useful lives, amortization is computed using the straight-line method over the
estimated economic lives of the respective intangible assets, ranging
from five to seven years.
Furthermore, we assess whether our long-lived assets including intangible assets and equity
investment in a privately-held company recorded under the cost method, should be tested for
recoverability periodically and whenever events or circumstances indicate that their carrying value
may not be recoverable. The amount of impairment, if any, is measured based on fair value, which is
determined using projected discounted future operating cash flows. Assets to be disposed of are
reported at the lower of the carrying amount or fair value less selling costs.
Inventories. Inventories are stated at the lower of cost, on a first-in, first-out basis, or
market. We use a standard cost system for purposes of determining cost. The standards are adjusted
periodically to represent actual cost. We regularly compare forecasted demand and the composition
of the forecast against inventory on hand and open purchase commitments in an effort to ensure the
carrying value of inventory does not exceed net realizable value. Accordingly, we may have to
record reductions to the carrying value of excess and obsolete inventory if forecasted demand
decreases.
Goodwill. Goodwill is not amortized, but instead is tested at least annually for impairment,
or more frequently when events or changes in circumstances indicate that the assets might be
impaired. Management considers our business as a whole to be its reporting unit for purposes of
testing for impairment. This impairment test is performed annually during the fiscal fourth
quarter. As of December 27, 2009, the fair value of the reporting unit substantially exceeded its
carrying value.
A two-step test is used to identify the potential impairment and to measure the amount of
goodwill impairment, if any. The first step is to compare the fair value of the reporting unit with
its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its
carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss
is measured by performing step two. Under step two, the impairment loss is measured by comparing
the implied fair value of the reporting unit goodwill with the carrying amount of goodwill.
Income Taxes. We account for income taxes using the asset and liability method, under which we
recognize deferred tax assets and liabilities for the future tax consequences attributable to
temporary differences between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and for net operating loss and tax credit carryforwards.
Tax positions that meet a more-likely-than-not recognition threshold are recognized in the
financial statements.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized
in income in the period that includes the enactment date. As a multinational corporation, we are
subject to complex tax laws and regulations in various jurisdictions. The application of tax laws
and regulations is subject to legal and factual interpretation, judgment, and uncertainty. Tax laws
themselves are subject to change as a result of changes in fiscal policy, changes in legislation,
evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign
taxes may be materially different from our estimates, which could result in the need to record
additional liabilities or potentially to reverse previously recorded tax liabilities.
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Stock-Based Compensation. We account for our stock-based awards to employees and non-employees
using the fair value method. Stock-based compensation cost is measured at grant date, based on the
fair value of the award, and is recognized as expense over the requisite service period. The fair
value of each unvested stock award is determined based on the closing price of our common stock at
grant date. For stock options, the measurement of stock-based compensation cost is based on several
criteria including, but not limited to, the valuation model used and associated input factors such
as expected term of the award, stock price volatility, dividend rate, risk free interest rate, and
award forfeiture rate. The input factors to use in the valuation model are based on subjective
future expectations combined with management judgment. If there is a difference between the
forfeiture assumptions used in determining stock-based compensation costs and the actual
forfeitures, which become known over time, we may change the assumptions used in determining
stock-based compensation costs. These changes may materially impact our results of operations in
the period such changes are made. See Note 10 in the accompanying notes to condensed consolidated
financial statements contained elsewhere herein for additional information and related disclosures.
Litigation Costs. We record a charge equal to at least the minimum estimated liability for a
loss contingency when both of the following conditions are met: (i) information available prior to
issuance of the financial statements indicates that it is probable that an asset had been impaired
or a liability had been incurred at the date of the financial statements and (ii) the range of loss
can be reasonably estimated. Legal and other litigation related costs are recognized as the
services are provided. We record insurance recoveries for litigation costs for which both
conditions are met: (i) the recovery is probable and (ii) collectability is reasonably assured.
The insurance recoveries recorded are only to the extent the litigation costs have been incurred
and recognized in the financial statements; however, it is reasonably possible that the actual
recovery may be significantly different from our estimates. There are many uncertainties associated
with any litigation, and we cannot provide assurance that any actions or other third party claims
against us will be resolved without costly litigation and/or substantial settlement charges. If any
of those events were to occur, our business, financial condition and results of operations could be
materially and adversely affected.
Recently Adopted Accounting Standards
See Note 1 of Notes to Condensed Consolidated Financial Statements for a description of the
recently adopted accounting standards.
Recently Issued Accounting Standards
See Note 1 of Notes to Condensed Consolidated Financial Statements for a description of the
recently issued accounting standards we have not yet adopted.
Liquidity and Capital Resources
At December 27, 2009, we had approximately $334.2 million in working capital and approximately
$268.8 million in cash and cash equivalents and current investments. At June 28, 2009, we had
approximately $354.3 million in working capital and approximately $302.4 million in cash and cash
equivalents and current investments. We invest in instruments that meet credit quality standards in
accordance with our investment guidelines. We limit our exposure to any one issuer or type of
investment with the exception of U.S. Government issued or U.S. Government sponsored entity
securities. Our other investments consisted of term deposits and fixed income securities as of
December 27, 2009 and we did not hold any auction rate securities or direct investments in
mortgage-backed securities. We have primarily funded our cash needs from continuing operations. As
part of our global initiatives, we currently plan to continue our strategic investment in research
and development, sales and marketing, capital equipment, and facilities. We may also consider
internal and external investment opportunities in order to achieve our growth and market leadership
goals, including business acquisitions, licensing and joint-development agreements with our
suppliers and other third parties.
In early August 2008, our Board of Directors authorized a plan to repurchase up to $100.0
million of our outstanding common stock. In April 2009, upon receipt of an unsolicited takeover
proposal and related tender offer of Broadcom Corporation to acquire us, our Board of Directors
elected to temporarily suspend any activity under the share repurchase plan. In light of Broadcoms
announcement of its decision to allow its tender offer to expire on July 14, 2009, Emulexs Board
of Directors elected to reactivate the $100.0 million share repurchase plan effective
July 15, 2009. Through December 27, 2009, the Company has repurchased 2.0 million shares of
its common stock for an aggregate purchase price of approximately $18.2 million or an average of
$9.12 per share under this plan. Our Board of Directors has not set an expiration date for the
plan.
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We believe that our existing cash and cash equivalents, current investments, and anticipated
cash flows from operating activities will be sufficient to support our working capital needs and
capital expenditure requirements for at least the next 12 months. We currently do not have any
outstanding lines of credit or other borrowings.
Cash provided by operating activities during the six months ended December 27, 2009 was
approximately $19.8 million compared to cash used in operating activities of approximately $10.7
million during the six months ended December 28, 2008. The current period cash provided by
operating activities was primarily due to net income of approximately $12.8 million before
adjustments of amortization of intangible assets of approximately $12.8 million, depreciation and
amortization of approximately $10.6 million, and share-based compensation expense of approximately
$8.6 million, partially offset by an increase in accounts and other receivables of approximately
$16.7 million.
Cash used in investing activities during the six months ended December 27, 2009 was
approximately $42.4 million compared to cash provided by investing activities of approximately
$63.3 million during the six months ended December 28, 2008. The current period usage of cash was
primarily due to a payment of approximately $20.0 million pursuant to a patent licensing
arrangement with a third party and a $10.0 million loan to a privately-held company. See Notes 5
and 6 of Notes to Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q.
We anticipate higher capital expenditures in the future as we continue to implement our global
initiatives and grow our company.
Cash used in financing activities for the six months ended December 27, 2009 was approximately
$18.8 million compared to approximately $38.3 million for the six months ended December 28, 2008.
The current period usage of cash was primarily due to the purchase of treasury stock of
approximately $18.2 million compared to approximately $39.9 million in the same period in the prior
year.
We have disclosed outstanding legal proceedings in Note 8 to our condensed consolidated
financial statements. Although we cannot be certain of the outcome of any litigation, we currently
believe the final resolution of outstanding litigation will not have a material adverse effect on
the Companys liquidity or capital resources.
The following summarizes our contractual obligations as of December 27, 2009, and the effect
such obligations are expected to have on our liquidity in future periods:
Payments Due by Period | ||||||||||||||||||||||||||||
(in thousands) | ||||||||||||||||||||||||||||
Remaining | ||||||||||||||||||||||||||||
Total | 2010 | 2011 | 2012 | 2013 | 2014 | Thereafter | ||||||||||||||||||||||
Leases (1) |
$ | 14,492 | $ | 3,080 | $ | 5,857 | $ | 3,907 | $ | 1,648 | $ | | $ | | ||||||||||||||
Purchase commitments |
38,102 | 37,938 | 164 | | | | | |||||||||||||||||||||
Other commitments (2) |
18,095 | 7,851 | 10,239 | 4 | 1 | | | |||||||||||||||||||||
Total |
$ | 70,689 | $ | 48,869 | $ | 16,260 | $ | 3,911 | $ | 1,649 | $ | | $ | | ||||||||||||||
(1) | Lease payments include common area maintenance (CAM) charges. |
|
(2) | Consists primarily of commitments for professional fees of
approximately $8.8 million, joint-development agreements of
approximately $3.5 million, and non-recurring engineering services of
approximately $3.0 million, but excludes approximately $32.5 million
of unrecognized tax benefits under FIN 48 for which we cannot make a
reasonably reliable estimate of the period of payment. |
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
Our cash and cash equivalents are not subject to significant interest rate risk due to their
short terms to maturity. Cash equivalents include money market funds that invest in U.S.
government securities and U.S. government sponsored entity securities. As of December 27, 2009, the
carrying value of our cash and cash equivalents approximated fair value.
As of December 27, 2009, our investment portfolio of approximately $16.1 million consists
primarily of term deposits and fixed income securities. We have the positive intent and ability to
hold these investments to maturity. We did not hold any auction rate securities or direct
investments in mortgage-backed securities as of December 27, 2009. The fair market value of our
investment portfolio is subject to interest rate risk and would decline in value if market interest
rates increased. If market interest rates were to increase immediately and uniformly by 10% from
the levels existing as of December 27, 2009, the decline in the fair value of the portfolio would
not be material to our financial position, results of operations and cash flows.
Foreign Currency Exchange Risk.
Our revenue and spending is transacted primarily in U.S. dollars; however, starting in fiscal
2009 we increased our transactions in other currencies to fund our global initiatives. As of
December 27, 2009 and December 28, 2008, a 10% change in the value of the related currencies would
not have a material impact on our results of operations and financial position.
Changes in exchange rates can also affect the volume of sales and the relative costs of
operations based overseas.
Item 4. Controls and Procedures
Under the supervision and with the participation of our management, including the Chief
Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our
disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the
period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that these disclosure controls and procedures are effective.
There were no changes in our internal control over financial reporting that occurred during
the three months ended December 27, 2009, that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
Litigation
On November 15, 2001, prior to the Companys acquisition of Vixel Corporation, a securities
class action was filed in the United States District Court in the Southern District of New York as
Case No. 01 CIV. 10053 (SAS), Master File No. 21 MC92 (SAS) against Vixel and two of its officers
and directors (one of which is James M. McCluney, the Companys current Chief Executive Officer and
President) and certain underwriters who participated in the Vixel initial public offering in late
1999. The amended complaint alleges violations under Section 10(b) of the Exchange Act and Section
11 of the Securities Act and seeks unspecified damages on behalf of persons who purchased Vixel
stock during the period October 1, 1999 through December 6, 2000. In October 2002, the parties
agreed to toll the statute of limitations with respect to Vixels officers and directors until
September 30, 2003, and on the basis of this agreement, Vixels officers and directors were
dismissed from the lawsuit without prejudice. During June 2003, Vixel and the other issuer
defendants in the action reached a tentative settlement with the plaintiffs that would, among other
things, result in the dismissal with prejudice of all claims against the defendants
and their officers and
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directors. In connection with the possible settlement, those officers
and directors who had entered tolling agreements with the plaintiffs agreed to extend those
agreements so that they would not expire prior to any settlement being finalized. Although Vixel
approved this settlement proposal in principle, it remained subject to a number of procedural
conditions, as well as formal approval by the court. On August 31, 2005, a Preliminary Order In
Connection With Settlement Proceedings was issued by the court which among other items, set a date
for a Settlement Fairness Hearing held on April 24, 2006, and the form of notice to the Settlement
Classes of the Issuers Settlement Stipulation. In December 2005, the settlement notices authorized
by the court were sent to former Vixel stockholders and the web site
www.iposecuritieslitigation.com was created for claimants, as well as a March 24, 2006 objection
deadline. At the Settlement Fairness Hearing held on April 24, 2006, the court raised the following
primary issues: (1) the (possible) change in value of the settlement since preliminary approval,
and whether the benefits of the settlement should be evaluated at the time of approval or at the
time of negotiation; (2) how the class certification argument before the Second Circuit Court of
Appeals could or would affect the fairness of the settlement; (3) how to evaluate the intangible
benefits of the settlement to the class members; and (4) how to value the $1 billion guarantee (for
the consolidated litigation involving Vixel and 297 other Issuers) by insurers in the stipulation
and agreement of settlement in light of the underwriters potential future settlements. The Court
did not rule on April 24, 2006 on the motion for final approval or objections. On June 6, 2006, the
Second Circuit Court of Appeals held oral arguments on the appeal by the underwriters of Judge
Scheindlins class certification decision. On or about July 17, 2006, Emulex assigned to the class
action plaintiffs any IPO claims that Emulex (Vixel) had against RBC Dain Rauscher in the IPO
litigation, as required by the settlement agreement. On December 5, 2006, the Second Circuit Court
of Appeals issued a decision reversing Judge Scheindlins class certification decision. On December
14, 2006, Judge Scheindlin issued an order to stay all proceedings pending a decision from the
Second Circuit on whether it will hear further argument. On about January 6, 2007, Emulex assigned
to the class action plaintiffs any IPO claims that Emulex (Vixel) had against The Bear Stearns
Companies Inc. and Bear Stearns & Co. Inc. in the IPO litigation, as required by the settlement
agreement. On April 6, 2007, the Second Circuit denied the plaintiffs petition for rehearing of
the decision denying class certification. During April 2007, counsel for Emulex and other Issuers
informed Judge Scheindlin that, in light of the Second Circuit opinion, the settlement agreement
could not be approved because the defined settlement class, like the litigation class, did not meet
the Second Circuit requirements for certification. Judge Scheindlin held a conference on May 30,
2007 to consider issues relating to the class definitions, the statute of limitations, settlement,
and discovery. On June 25, 2007, Judge Scheindlin signed a Stipulation and Order submitted by the
parties which terminated the June 10, 2004 Stipulation and Agreement of Settlement with Defendant
Issuers and Individuals. On June 26, 2007, a document production request from the plaintiffs to all
298 issuers (including Vixel) was received, covering documents from each issuers inception through
December 31, 2001. In September 2007, due to the expiration of the tolling agreements, those
officers and directors who had entered tolling agreements with the plaintiffs agreed to extend
those agreements until August 27, 2010. On November 15, 2007, the issuers and their respective
insurers entered into an Insurers-Insureds Agreement (replacing an earlier agreement), which
provides for the insurers to pay for certain defense costs under applicable issuer insurance
policies. On December 21, 2007, issuer defendants filed an opposition to plaintiffs motion for
class certification of certain focus cases. On March 26, 2008, defendants motion to dismiss was
denied except to certain claims by plaintiffs who did not suffer damages or whose claims were time
barred. On Oct. 10, 2008, Judge Scheindlin signed an order granting the plaintiffs request to
withdraw the class certification motion in the six focus cases (Emulex/Vixel is not in a focus
case). On April 1, 2009, the parties signed a Stipulation and Agreement of Settlement (the 2009
Settlement) which the District Court subsequently approved on October 6, 2009. The 2009
Settlement provides for a settlement amount of $586 million, and Emulex has no obligation to pay
any part of that amount. On October 23, 2009, Lester Baum, Mike Hart, and Sue Shadley filed a
petition for permission to appeal the class certification order.
On January 27, 2009, a patent infringement lawsuit was filed in the United States District
Court in the Central District of California as Case No. CV09-00605 R (JWJx) against Emulex by
Microprocessor Enhancement Corporation and Michael H. Branigin. The complaint alleges infringement
of U.S. Patent No. 5,471,593, and seeks a judgment for damages, injunctive relief, and an award of
attorneys fees and costs. On March 25, 2009, Emulex filed an answer to the complaint denying
allegations and asserting affirmative defenses. On Oct. 13, 2009, the Company filed documents
opposing a summary judgment motion by the Plaintiffs. A hearing of the summary judgment motion was
held on Nov. 16, 2009, and the motion was taken under submission.
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On April 27, 2009, Reid Middleton filed a lawsuit in the Court of Chancery of the State of
Delaware on behalf of himself and all other similarly situated stockholders of the Company and
derivatively on behalf of the Company.
The original complaint named the members of the Board as defendants and the Company as a
nominal defendant. The complaint asserted a claim for breach of fiduciary duty on behalf of a
putative class of holders of shares of the Companys common stock (the Shares) and a derivative
claim for devaluation of the Company stemming from the Companys January 2009 amendments to its
Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and
amendments to its Key Employee Retention Agreements, and actions in response to Broadcoms
announcement of its unsolicited April 21, 2009 takeover proposal to acquire the Company. The
original complaint sought declaratory and injunctive relief, compensatory damages, interest and
costs, including attorneys and expert fees.
On May 6, 2009, Jim Robbins filed a lawsuit in the Superior Court of the State of California,
County of Orange, on behalf of himself and all other similarly situated stockholders of the Company
(the California Litigation). The complaint names the members of the Board and the Company as
defendants. The complaint asserts a claim for breach of fiduciary duty on behalf of a putative
class of holders of Shares relating to the Companys January 2009 amendments to its Bylaws,
adoption of a new stockholder rights plan to replace its expiring rights plan, and amendments to
its Key Employee Retention Agreements, and actions in response to Broadcoms announcement of its
proposal to acquire the Company. The complaint seeks declaratory and injunctive relief, a
constructive trust upon any benefits improperly received as a result of the alleged wrongful
conduct and breach of any duty owed to the holders of Shares, and costs, including attorneys and
expert fees. This lawsuit was dismissed without prejudice on December 15, 2009.
On May 7, 2009, Kamwai Fred Chan filed a lawsuit in the Court of Chancery of the State of
Delaware on behalf of himself and all other similarly situated stockholders of the Company. The
complaint names the members of the Board and the Company as defendants. The complaint asserts a
claim for breach of fiduciary duty on behalf of a putative class of holders of Shares relating to
the Companys January 2009 amendments to its Bylaws, adoption of a new stockholder rights plan to
replace its expiring rights plan, and amendments to its Key Employee Retention Agreements, and
actions in response to Broadcoms announcement of its proposal to acquire the Company. The
complaint seeks declaratory and injunctive relief, compensatory damages, interest and costs,
including attorneys and expert fees.
On May 11, 2009, the Court of Chancery of the State of Delaware granted plaintiff Reid
Middletons motion to expedite proceedings and set a trial date in the three foregoing Delaware
lawsuits beginning on July 8, 2009. On July 6, 2009, the Court of Chancery continued the July 8,
2009 trial date indefinitely. On December 3, 2009, the plaintiffs attorneys filed an application
for an award of attorneys fees and expenses. The Court rejected the plaintiffs request for
attorneys fees on December 18, 2009.
On May 11, 2009, Pipefitters Local No. 636 Defined Benefit Plan filed a lawsuit in the Court
of Chancery of the State of Delaware on behalf of itself and all other similarly situated
stockholders of the Company and derivatively on behalf of the Company. The original complaint named
the members of the Companys Board as defendants and the Company as a nominal defendant. The
complaint asserted a claim for breach of fiduciary duty on behalf of a putative class of holders of
Shares relating to the Companys January 2009 amendments to its Bylaws, adoption of a new
shareholder rights plan to replace its expiring rights plan, amendments to its Key Employee
Retention Agreements, and actions in response to Broadcoms announcement of its proposal to acquire
the Company. The original complaint also asserted a derivative claim for breach of fiduciary duty
based on the same actions. The original complaint sought declaratory and injunctive relief,
including mandatory injunctive relief, and costs, including attorneys and expert fees.
On May 12, 2009, Norfolk County Retirement System filed a lawsuit in the Court of Chancery of
the State of Delaware on behalf of itself and all other similarly situated stockholders of the
Company. The original complaint named the members of the Companys Board and the Company as
defendants. The original complaint asserted a claim for breach of fiduciary duty on behalf of a
putative class of holders of Shares relating to the Companys January 2009 amendments to its
Bylaws, adoption of a new shareholder rights plan to replace its expiring rights plan, and
amendments to its Key Employee Retention Agreements, and actions in response to Broadcoms
announcement of its proposal to acquire the Company. The original complaint sought declaratory and
injunctive relief, compensatory damages, interest and costs, including attorneys and expert fees.
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On September 17, 2009, Reid Middleton, Pipefitters Local No. 636 Defined Benefit Plan and
Norfolk County Retirement System (together the Plaintiffs) filed a Verified Amended Class Action
and Derivative Complaint in the Court of Chancery of the State of Delaware. The amended complaint
is brought on behalf of Plaintiffs and all other similarly situated stockholders of the Company
and, alternatively, derivatively on behalf of the Company. The complaint names the members of the
Board as defendants and the Company as a nominal defendant. The complaint asserts claims for breach
of fiduciary duty on behalf of a putative class of holders of Shares and, alternatively, a
derivative claim for devaluation of the Company stemming from the Companys January 2009 amendments
to its Bylaws, adoption of a new stockholder rights plan to replace its expiring rights plan, and
amendments to its Key Employee Retention Agreements, and actions in response to Broadcoms
announcement of its proposal to acquire the Company. The complaint seeks declaratory relief,
compensatory damages, interest and costs, including attorneys and expert fees. On October 13,
2009, the defendants filed an answer to the amended complaint.
On September 14, 2009, Broadcom Corporation filed a patent infringement lawsuit against the
Company in the United States District Court, in the Central District of California. The suit
alleges that the Company is infringing 10 Broadcom patents covering certain data and storage
networking technologies. The complaint seeks declaratory and injunctive relief, monetary damages,
and interest and costs, including attorneys and expert fees. On November 4, 2009, the Company
filed its answer and affirmative defenses to the patent infringement complaint alleging that it
believes that the Broadcom patents at issue are invalid or not infringed, or both. In addition,
the Company asserted counterclaims for declaratory judgment of invalidity and non-infringement
against each of the Broadcom patents at issue, and seeks award of attorneys fees, costs, and
expenses. On January 11, 2010, the Court set a trial date of September 20, 2011.
On November 9, 2009, the Company filed a lawsuit against Broadcom Corporation alleging that
Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws, as well as
made defamatory statements and engaged in acts of unfair competition. The complaint seeks actual
and punitive damages, attorneys fees and costs, and injunctive relief against Broadcom. On
January 4, 2010, the Company filed an amended complaint. The amended complaint alleges that
Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws and made
defamatory statements. The amended complaint seeks actual and punitive damages, attorneys fees
and costs, and injunctive relief. Broadcoms response to the amended complaint is due to be filed
on February 4, 2010.
In addition to the ongoing litigation discussed above, the Company is involved in various
claims and legal actions arising in the ordinary course of business. In the opinion of management,
the ultimate disposition of the open matters will not have a material adverse effect on the
Companys consolidated financial position, results of operations or liquidity.
Item 1A. Risk Factors
The recent economic downturn has resulted in a reduction in information technology spending in
general, or spending on computer and storage systems in particular, that will adversely affect our
revenues and results of operations in the near term and possibly beyond.
The demand for our network storage products has been driven by the demand for high performance
storage networking products and solutions that support enterprise computing applications, including
on-line transaction processing, data mining, data warehousing, multimedia, and Internet
applications. The recent economic downturn and related disruptions in world credit and equity
markets as well as the related failures of several large financial institutions have resulted in a
global downturn in spending on information technology. If the downturn in the economy results in a
significant downturn in demand for such products, solutions, and applications, it will adversely
affect our business, results of operations, and financial condition in the near term and possibly
beyond. The adverse effects of any sustained downturn in information technology spending on our
operating results may be exacerbated by our research and development investments, strategic
investments and merger and acquisition activity, as well as customer service and support, which are
expected to continue despite any such downturn.
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Our markets are highly competitive and our business and results of operations may be adversely
affected by entry of new competitors into the markets, aggressive pricing, and the introduction or
expansion of competitive products and technologies.
The markets for our products are highly competitive and are characterized by rapid
technological advances, price erosion, frequent new product introductions, and evolving industry
standards. We expect that our markets will continue to attract new competition. Our current and
potential competition consists of major domestic and international companies, some of which have
substantially greater financial, technical, marketing, and distribution resources than we have.
Additional companies, including but not limited to our suppliers, strategic partners, Original
Equipment Manufacturer (OEM) customers, and emerging companies, may enter the markets for our
storage networking products and new or stronger competitors may emerge as a result of consolidation
movements in the marketplace. Additionally, our existing competitors continue to introduce products
with improved price/performance characteristics, and we may have to do the same to remain
competitive. Furthermore, competitors may introduce new products to the market before we do, and
thus obtain a first to market advantage over us. Increased competition could result in increased
price competition, reduced revenues, lower profit margins or loss of market share, any of which
could have a material adverse effect on our business, results of operations, and financial
condition.
A significant portion of our business depends upon the continued growth of the storage networking
market and our business will be adversely affected if such growth does not occur, occurs more
slowly than we anticipate, or declines.
The size of our potential market is largely dependent on the overall demand for storage in
general and in particular upon the broadening acceptance of our storage networking technologies. We
believe that our investment in multi protocol solutions that address the high performance needs of
the storage networking market provides the greatest opportunity for our revenue growth and
profitability for the future. However, the market for storage networking products may not gain
broader acceptance and customers may choose alternative technologies that we are not investing in,
and/or products supplied by other companies. Interest continues for other storage networking
technologies such as Internet Small Computer Systems Interface (iSCSI), which may satisfy some
Input/Output (I/O) connectivity requirements through standard Ethernet adapters and software at
little to no incremental cost to end users. These software only iSCSI solutions compete with our
Host Server Products, particularly in the low end of the market. We have also launched Converged
Network Adapters (CNAs) using Fibre Channel over Ethernet (FCoE) or iSCSI protocols which may be
used by the same customers impacting our Fibre Channel HBAs and mezzanine card revenues more than
we anticipate. In addition, other technologies such as port bypass circuits (PBCs) and serial
attached SCSI (SAS) compete with our embedded storage products today, and we may not be able to
develop products fast enough or at a sufficiently low cost to compete in this market. Furthermore,
since our products are sold as parts of integrated systems, demand for our products is driven by
the demand for these integrated systems, including other companies complementary products. A lack
of demand for the integrated systems or a lack of complementary products required for these
integrated systems to be deployed could have a material adverse effect on our business, results of
operations, and financial condition. If the storage networking market does not grow, grows more
slowly than we anticipate, declines, attracts more competitors than we expect, as discussed below,
or if our products do not achieve continued market acceptance, our business, results of operations,
and financial condition could be materially adversely affected.
Because a significant portion of our revenues is generated from sales to a limited number of
customers, none of which are subject to exclusive or long-term contracts, the loss of one or more
of these customers, or our customers failure to make timely payments to us, could adversely
affect our business.
We rely almost exclusively on OEMs and sales through distribution channels for our revenue.
For both the three and six months ended December 27, 2009, we derived approximately 84% of our net
revenues from sales to OEM customers and approximately 16% from sales through distribution.
Furthermore, as some of our sales through distribution channels consist of OEM products, OEM
customers effectively generated approximately 92% of our revenue for both the three and six months
ended December 27, 2009, respectively. Moreover, direct sales to our top five customers accounted
for approximately 58% and 59% for the three and six months ended December 27, 2009, respectively.
We may be unable to retain our current OEM and distributor customers or to recruit additional or
replacement customers.
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Although we have attempted to expand our base of customers, including customers for embedded
storage products, we believe our revenues in the future will continue to be similarly derived from
a limited number of customers. As a result, to the extent that sales to any of our significant
customers do not increase in accordance with our expectations or are reduced or delayed, our
business, results of operations, and financial condition could be materially adversely affected.
As is common in the technology industry, our agreements with OEMs and distributors are
typically non-exclusive, have no volume commitments, and often may be terminated by either party
without cause. It is increasingly commonplace for our OEM and distributor customers to utilize or
carry competing product lines. If we were to lose business from one or more significant OEM or
distributor customers to a competitor, our business, results of operations, and financial condition
could be materially adversely affected. In addition, our OEMs may elect to change their business
practices in ways that affect the timing of our revenues, which may materially adversely affect our
business, results of operations, and financial condition.
Our operating results are difficult to forecast and could be adversely affected by many factors
and our stock price may decline if our results fail to meet expectations.
Our revenues and results of operations have varied on a quarterly basis in the past and may
vary significantly in the future. Accordingly, we believe that period-to-period comparisons of our
results of operations are not necessarily meaningful, and you should not rely on such comparisons
as indications of our future performance. We may be unable to maintain our current levels of growth
or profitability in the future. Our revenues and results of operations are difficult to forecast
and could be adversely affected by many factors, including, but not limited to:
| Changes in the size, mix, timing and terms of OEM and/or other customer orders; |
||
| Changes in the sales and deployment cycles for our products and/or desired inventory
levels for our products; |
||
| Acquisitions or strategic investments by our customers, competitors or us; |
||
| Timing and market acceptance of new or enhanced product introductions by us, our OEM
customers and/or competitors; |
||
| Market share losses or difficulty in gaining incremental market share; |
||
| Fluctuations in product development, procurement, resource utilization and other
operating expenses; |
||
| Reduced demand from our customers if there is a shortage of, or difficulties in
acquiring, components or other products, such as Fibre Channel or serial advanced
technology attachment (SATA) disk drives and optical modules, used in conjunction with our
products in the deployment of systems; |
||
| Inability of our electronics manufacturing service providers or suppliers to produce
and distribute our products in a timely fashion; |
||
| Difficulties with updates, changes or additions to our information technology systems; |
||
| Breaches of our network security, including viruses; |
||
| Changes in general social and economic conditions, including but not limited to natural
disasters, terrorism, public health crises, slower than expected market growth, reduced
economic activity, delayed economic recovery, loss of consumer confidence, increased energy
costs, adverse business conditions and liquidity concerns, concerns about inflation or
deflation, recession, and reduced business profits and capital spending, with resulting
changes in customer technology budgeting and spending; |
||
| Seasonality. |
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As a result of these and other unexpected factors or developments, future operating results
may be from time to time below the expectations of investors or market analysts, which would have a
material adverse effect on our stock price.
A number of factors including relatively small backlog of unfilled orders, possible customer
delays or deferrals and our tendency to generate a large percentage of our quarterly sales near
the end of the quarter contribute to possible fluctuations in our operating results that could
have an adverse impact on our results of operations and stock price.
Historically, we have generally shipped products quickly after we received orders, meaning
that we do not always have a significant backlog of unfilled orders, in particular for our HBA
products. As a result, our revenues in a given quarter may depend substantially on orders booked
during that quarter. Alternatively, orders already in backlog may be deferred or cancelled. Also,
we have typically generated a large percentage of our quarterly revenues in the last month of the
quarter. As a result of our expense levels being largely based on our expectations of future sales
and continued investment in research and development, in the event we experience unexpected
decreases in sales, our expenses may be disproportionately large relative to our revenues, and we
may be unable to adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. A material shortfall in sales in relation to our quarterly expectations or any delay,
deferral, or cancellation of customer orders would likely have an immediate and adverse impact on
our results of operations and may adversely affect our stock price.
Our industry is subject to rapid technological change, thus our results of operations could be
adversely affected if we are unable to keep pace with the changes to successfully compete.
The markets for our products are characterized by rapidly changing technology, evolving
industry standards, and the frequent introduction of new products and enhancements. Our future
success depends in large part on our ability to enhance our existing products and to introduce new
products on a timely basis to meet changes in customer preferences and evolving industry standards.
Currently, new and proposed technologies such as eight and 16 Gb/s Fibre Channel solutions; FCoE;
Enhanced Ethernet; 10 Gb/s Ethernet solutions; low latency Ethernet solutions; Data Center
Ethernet; Infiniband; iSCSI; PCI-X 2.0; PCI Express Gen one, two, and three; PCI Express Advanced
Switching; SATA; SAS; and Remote Direct Memory Access (RDMA); are in development by many companies
and their ultimate acceptance and deployment in the market is uncertain. We are developing some,
but not all of these technologies, and we cannot be sure that the technologies we chose to develop
will achieve market acceptance, or that technologies that we chose not to develop will be available
to purchase or license from third parties or will be immaterial to our business. Furthermore, if
our products are not available in time for the qualification cycle at an OEM, we may be forced to
wait for the next qualification cycle which is typically three years if at all. In addition, new
products and enhancements developed by us may not be backwards compatible to existing equipment
already installed in the market. If we are unable, for technological or other reasons, to develop
new products, enhance or sell existing products, or consume raw materials in a timely and cost
effective manner in response to technological and market changes, our business, results of
operations, and financial condition may be materially adversely affected.
We have experienced losses in our history and may experience losses in our future that may
adversely affect our financial condition.
We have experienced losses in our history, which may be caused by a downturn in the economy or
an impairment of long-lived assets and/or goodwill. We may experience losses in the future due to
an impairment of our long-lived assets, goodwill, and/or equity investments recorded under the cost
method. To the extent that we are unable to generate positive operating profits or positive cash
flow from operations, our financial condition may be materially adversely affected.
The timing of migration of our customers toward newer product platforms varies and may have a
significant adverse effect.
As our customers migrate from one platform to the enhanced price/performance of the next
platform, we may experience reduced revenue, gross profit, or gross margin levels associated with
lower average selling prices or higher relative product costs associated with improved performance.
While we regularly compare forecasted demand for our products against inventory on hand and open
purchase commitments, to the extent that customers
migrate more quickly than anticipated, the corresponding reduction in demand for older product
platforms may result in excess or obsolete inventory and related charges which could have a
material adverse effect on our financial condition and results of operations.
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The migration of our customers from purchasing our products through the distribution channel and
toward OEM server manufacturers may have a significant adverse effect.
As our customers migrate from purchasing our products through the distribution channel and
toward purchasing our products through OEM server manufacturers, which has a lower average selling
price, this may have a material adverse effect on our financial condition and results of
operations.
Any failure of our OEM customers to keep up with rapid technological change and to successfully
market and sell systems that incorporate new technologies could adversely affect our business.
Our revenues depend significantly upon the ability and willingness of our OEM customers to
commit significant resources to develop, promote, and deliver products that incorporate our
technology. In addition, if our customers products are not commercially successful, it would have
a materially adverse effect on our business, results of operations, and financial condition.
Rapid changes in the evolution of technology, including the unexpected extent or timing of
the transition from HBA solutions or embedded switch box solutions to lower priced ASIC solutions,
could adversely affect our business.
Historically, the electronics industry has developed higher performance application specific
integrated circuits (ASICs) that create chip level solutions that replace selected board level or
box level solutions at a significantly lower average selling price. We have previously experienced
this trend and expect it to continue in the future. If this transition is more abrupt or is more
widespread than anticipated, there can be no assurance that we will be able to modify our business
model in a timely manner, if at all, in order to mitigate the effects of this transition on our
business, results of operations, and financial position.
If customers elect to utilize lower-end HBAs in higher-end environments or applications, our
business and financial condition could be negatively affected.
We supply three families of HBAs that target separate high-end, midrange and small to medium
sized business user (SMB) markets. Historically, the majority of our storage networking revenue has
come from our high-end server and storage solutions. In the future, increased revenues are expected
to come from dual channel adapters, midrange server, and storage solutions, which have lower
average selling prices per port. If customers elect to utilize midrange HBAs in higher-end
environments or applications, or migrate to dual channel adapters faster than we anticipate, our
business and financial condition could be negatively affected.
Advancement of storage device capacity technology may not allow for additional revenue growth.
Storage device density continues to improve rapidly and at some point in the future, the
industry may experience a period where the advancement in technology may increase storage device
capacity to a level that may equal or exceed the need for digital data storage requirements. This
would result in a situation where the number of units of storage devices required in the
marketplace may flatten out or even decrease. Our growth in revenue depends on growth in unit
shipments to offset declining average selling prices. To the extent that growth in storage device
unit demand slows or decreases, our financial condition and results of operations may be materially
adversely affected.
A decrease in the average unit selling prices or an increase in the manufactured cost of our
products due to inflation or other factors could adversely affect our revenue, gross margins and
financial performance.
In the past, we have experienced downward pressure on the average unit selling prices of our
products, and we expect this trend to continue. Furthermore, we may provide pricing discounts to
customers based upon volume purchase criteria, and achievement of such discounts may reduce our
average unit selling prices. To the extent that growth in unit demand fails to offset decreases in
average unit selling prices, our revenues and financial
performance could be materially adversely affected. Although we have historically achieved
offsetting cost reductions, to the extent that average unit selling prices of our products decrease
without a corresponding decrease in the costs of such products, our gross margins and financial
performance could be materially adversely affected. Our gross margins could also be adversely
affected by a shift in the mix of product sales to lower gross margin products. Furthermore, as our
products are manufactured internationally, cost reductions would be more difficult to achieve if
the value of the U.S. dollar continues to deteriorate. Moreover, if the manufactured cost of our
products were to increase due to inflation or other factors and we cannot pass along the increase
in our costs to our customers, our gross margins and financial performance could be materially
adversely affected.
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Delays in product development could adversely affect our business.
We have experienced delays in product development in the past and may experience similar
delays in the future. Prior delays have resulted from numerous factors, which may include, but are
not limited to:
| Difficulties in hiring and retaining necessary employees and independent contractors; |
||
| Difficulties in reallocating engineering resources and other resource limitations; |
||
| Unanticipated engineering or manufacturing complexity, including from third party
suppliers of intellectual property such as foundries of our ASICs; |
||
| Undetected errors or failures in our products; |
||
| Changing OEM product specifications; |
||
| Delays in the acceptance or shipment of products by OEM customers; and |
||
| Changing market or competitive product requirements. |
Given the short product life cycles in the markets for our products and the relatively long
product development cycles, any delay or unanticipated difficulty associated with new product
introductions or product enhancements could have a material adverse effect on our business, results
of operations, and financial condition.
Our joint development activities may result in products that are not commercially successful or
that are not available in a timely fashion.
We have engaged in joint development projects with customers, companies we have investments
in, and third parties in the past and we expect to continue doing so in the future. Currently, we
have investments in, receivables from, and commitments to various third parties related to these
joint development efforts. Joint development can magnify several risks for us, including the loss
of control over development of aspects of the jointly developed products and over the timing of
product availability. Accordingly, we face increased risk that joint development activities will
result in products that are not commercially successful or that are not available in a timely
fashion. Any failure to timely develop commercially successful products through our joint
development activities could have a material adverse effect on our business, results of operations,
and financial condition.
A change in our business relationships with our third party suppliers or our electronics
manufacturing service providers could adversely affect our business.
We rely on third party suppliers for components and the manufacture of our products, and we
have experienced delays or difficulty in securing components and finished goods in the past. Delays
or difficulty in securing components or finished goods at reasonable cost may be caused by numerous
factors including, but not limited to:
| Discontinued production by a supplier; |
||
| Required long-term purchase commitments; |
||
| Undetected errors, failures or production quality issues, including projected failures
that may constitute epidemic failure rates specified in agreements with our customers or
that may require us to make concessions or accommodations for continuing customer
relationships; |
||
| Timeliness of product delivery; |
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| Sole sourcing and components made by a small number of suppliers, including the
inability to obtain components and finished goods at reasonable cost from such sources and
suppliers; |
||
| Financial stability and viability of our suppliers and electronics manufacturing
service (EMS) providers; |
||
| Changes in business strategies of our suppliers and EMS providers; |
||
| Increases in manufacturing costs due to lower volumes or more complex manufacturing
process than anticipated; |
||
| Disruption in shipping channels; |
||
| Natural disasters; |
||
| Inability or unwillingness of our suppliers or EMS providers to continue their business
with us; |
||
| Environmental, tax or legislative changes in the location where our products are
produced or delivered; |
||
| Difficulties associated with international operations; and |
||
| Market shortages. |
There is a risk that we will not be able to retain our current suppliers or change to
alternative suppliers. An interruption in supply, the cost of shifting to a new supplier or EMS
providers, disputes with suppliers or EMS providers could have a material adverse effect on our
business, results of operations, and financial condition.
As we have transitioned the material procurement and management for our key components used in
our board or box level products to our EMS providers, we face increasing risks associated with
ensuring product availability. Further, an adverse inventory management control issue by one or
more of our third party suppliers could have a material adverse effect on our business, results of
operations, and financial condition. We also purchase ASIC components from sole source suppliers,
including LSI Corporation, Marvell Technology Group Ltd., Intel Corporation, and ServerEngines
Corporation, who in turn rely on a limited number of their suppliers to manufacture ASICs, all of
which create risks in assuring such component availability.
Unsolicited takeover proposals may be disruptive to our business and may adversely affect our
operations; results and our ability to retain key employees.
On April 21, 2009, we received an unsolicited takeover proposal from Broadcom Corporation
(Broadcom) to acquire all of our outstanding shares of common stock. While Broadcom has allowed
its tender offer to expire, there can be no assurance that Broadcom or another third party will not
make an unsolicited takeover proposal in the future. The review and consideration of any takeover
proposal may be a significant distraction for our management and employees and could require the
expenditure of significant time and resources by us.
Moreover, any unsolicited takeover proposal may create uncertainty for our employees and this
uncertainty may adversely affect our ability to retain key employees and to hire new talent. Any
such takeover proposal may also create uncertainty for our customers, suppliers and other business
partners, which may cause them to terminate, or not to renew or enter into, arrangements with us.
The uncertainty arising from unsolicited takeover proposals and any related costly litigation may
disrupt our business, which could result in an adverse effect on our operating results. Management
and employee distraction related to any such takeover proposal also may adversely impact our
ability to optimally conduct our business and pursue our strategic objectives.
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We have entered into Key Employee Retention Agreements with four of our current executive
officers, and adopted a Change in Control Retention Plan, in which currently an additional 23 key
employees participate. The participants of these retention arrangements may be entitled to
severance payments and benefits, based on a period of between twelve months and two years, upon a
termination of their employment by us without cause or by them for good reason in connection with a
change of control of our company (each as defined in the applicable agreement or plan). These
retention arrangements may not be adequate to allow us to retain critical employees during a time
when a change in control is being proposed or is imminent.
If our intellectual property protections are inadequate, it could adversely affect our business.
We believe that our continued success depends primarily on continuing innovation, marketing,
and technical expertise, as well as the quality of product support and customer relations. At the
same time, our success is partially dependent on the proprietary technology contained in our
products. We currently rely on a combination of patents, copyrights, trademarks, trade secret laws,
and contractual provisions to establish and protect our intellectual property rights in our
products.
We cannot be certain that the steps we take to protect our intellectual property will
adequately protect our proprietary rights, that others will not independently develop or otherwise
acquire equivalent or superior technology, or that we can maintain such technology as trade
secrets. In addition, the laws of some of the countries in which our products are or may be
developed, manufactured, or sold may not protect our products and intellectual property rights to
the same extent as the laws of the United States, or at all. Furthermore, we enter into various
development projects and arrangements with other companies. In some cases, these arrangements allow
for the sharing or use of our intellectual property. Our failure to protect our intellectual
property rights could have a material adverse effect on our business, results of operations, and
financial condition. We attempt to mitigate this risk by obtaining indemnification from others,
where possible.
Certain of our software (as well as that of our customers) may be derived from open source
software that is generally made available to the public by its authors and/or other third parties.
Such open source software is often made available to us under licenses, such as the GNU General
Public License (GPL), which impose certain obligations on us in the event we were to distribute
derivative works of the open source software. These obligations may require us to make source code
for the derivative works available to the public, or license such derivative works under a
particular type of license, rather than the forms of licenses customarily used to protect our
intellectual property. In the event the copyright holder of any open source software were to
successfully establish in court that we had not complied with the terms of a license for a
particular work, we could be required to release the source code of that work to the public and/or
stop distribution of that work.
Third party claims of intellectual property infringement could adversely affect our business.
We believe that our products and technology do not infringe on the intellectual property
rights of others or upon intellectual property rights that may be granted in the future pursuant to
pending applications. We occasionally receive communications from third parties alleging patent
infringement, and there is always the chance that third parties may assert infringement claims
against us. Any such claims, with or without merit, could result in costly litigation, cause
product shipment delays, or require us to enter into royalty or licensing agreements, which may or
may not be available. Furthermore, we have in the past obtained, and may be required in the future
to obtain, licenses of technology owned by other parties. We cannot be certain that the necessary
licenses will be available or that they can be obtained on commercially reasonable terms. If we
were to fail to obtain such royalty or licensing agreements in a timely manner and on reasonable
terms, our business, results of operations, and financial condition could be materially adversely
affected.
Broadcom recently filed a patent infringement suit against us alleging that we are infringing
on 10 Broadcom patents covering certain data and storage networking technologies. Ongoing
lawsuits, such as the action brought by Broadcom present inherent risks, any of which could have a
material adverse effect on our business, financial condition, or results of operations. Such
potential risks include continuing expenses of litigation, risk of loss of patent rights, risk of
injunction against the sale of products incorporating the technology in question, counterclaims,
attorneys fees, and diversion of managements attention from other business matters. See
Legal Proceedings in Item 1, Part I of this Form 10-Q.
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The inability or increased cost of attracting, motivating, or retaining key managerial and
technical personnel could adversely affect our business.
Our success depends to a significant degree upon the performance and continued service of key
managers, as well as engineers involved in the development of our storage networking technologies
and technical support of our storage networking products and customers. Competition for such highly
skilled employees in the communities in which we operate, as well as our industry, is intense, and
we cannot be certain that we will be successful in recruiting, training, and retaining such
personnel. In addition, employees may leave us and subsequently compete against us, and there may
be costs relating to their departure. Also, many of these key managerial and technical personnel
receive stock options or unvested stock as part of our employee retention initiatives. The number
of shares authorized under stock based plans may be insufficient and shareholders may not approve
to increase the number of authorized shares. New regulations, volatility in the stock market, and
other factors could diminish the value of our stock options or unvested stock, putting us at a
competitive disadvantage and forcing us to use more cash compensation. If we are unable to attract
new managerial and technical employees, or are unable to retain and motivate our current key
managerial and technical employees, or are forced to use more cash compensation to retain or
replace key personnel, our business, results of operations, and financial condition could be
materially adversely affected.
Our international business activities subject us to risks that could adversely affect our
business.
For the three and six months ended December 27, 2009, sales in the United States accounted for
approximately 31% of our total net revenues, sales in Asia Pacific accounted for approximately 37%
and 36% of our total net revenues, respectively, and sales in Europe, Middle East, Africa, and the
rest of the world accounted for approximately 32% and 33% of our total net revenues, respectively
based on billed-to address. We expect that our sales will be similarly distributed for the
foreseeable future. However, because we sell to OEMs and distributors who ultimately resell our
products to their customers, the geographic mix of our sales may not be reflective of the
geographic mix of end-user demand or installations. All of our sales are currently denominated in
U.S. dollars. As a result, if the value of the U.S. dollar increases relative to foreign
currencies, our products could become less competitive in international markets. In addition, an
increasing amount of our expenses will be incurred in currencies other than U.S. dollars and as a
result, we will be required from time to time to convert currencies to meet our obligations.
Additionally, our suppliers are increasingly located outside the U.S., and a significant portion of
our products is produced at our EMS providers production facilities in Thailand and Malaysia.
Furthermore, in connection with the reorganization of our international subsidiaries, we
established a company in Ireland, and a significant portion of our sales and operations will now
also occur in countries outside of the U.S. As a result, we are subject to the risks inherent in
international operations. Our international business activities could be affected, limited or
disrupted by a variety of factors, including, but not limited to:
| Imposition of or changes in governmental controls, taxes, tariffs, trade restrictions,
and regulatory requirements to our current or future operations; |
||
| Costs and risks of localizing products for international countries; |
||
| Longer accounts receivable payment cycles; |
||
| Changes in the value of local currencies relative to our functional currency; |
||
| Fluctuations in freight costs and potential disruptions in the transportation
infrastructure for our products and components; |
||
| Import and export restrictions; |
||
| Loss of tax benefits or increases in tax expenses; |
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| General economic and social conditions within international countries; |
||
| Taxation in multiple jurisdictions; |
||
| Difficulty maintaining management oversight and control of remote locations; |
||
| Potential restrictions on transferring funds between countries and difficulties
associated with repatriating cash generated or held outside of the U.S. in a tax-efficient
manner; |
||
| The increased travel, infrastructure, accounting, and legal compliance costs associated
with multiple international locations; and |
||
| Political instability, war, or terrorism. |
All of these factors could harm future sales of our products to international customers or
production of our products outside of the United States, and have a material adverse effect on our
business, results of operations, and financial condition.
Potential acquisitions or strategic investments may become more costly or less profitable than
originally anticipated and may adversely affect the price of our common stock.
We may pursue acquisitions or strategic investments, including loans to private companies,
that could provide new technologies, products, or service offerings. Acquisitions or strategic
investments may negatively impact our results of operations as a result of operating losses
incurred by the acquired entity, the use of significant amounts of cash, potentially dilutive
issuances of equity or equity-linked securities, incurrence of debt, amortization of intangible
assets with determinable lives, or impairment of intangible assets. Furthermore, we may incur
significant expenses pursuing acquisitions or strategic investments that ultimately may not be
completed. Moreover, to the extent that any proposed acquisition or strategic investment that is
not favorably received by stockholders, analysts and others in the investment community, the price
of our stock could be adversely affected. In addition, acquisitions or strategic investments
involve numerous risks, including, but not limited to:
| Difficulties in the assimilation of the operations, technologies, products, and
personnel of the acquired company; |
||
| Purchased technology that is not adopted by customers in the way or the time frame we
anticipated; |
||
| Diversion of managements attention from other business concerns; |
||
| Risks of entering markets in which we have limited or no prior experience; |
||
| Risks associated with assuming the legal obligations of the acquired company; |
||
| Losses incurred by our strategic investments that may be required to be reflected in
our results; |
||
| Risks related to the effect that the acquired companys internal control processes
might have on our financial reporting and managements report on our internal controls over
financial reporting; |
||
| Potential loss of key employees of the company we invested in or acquired; |
||
| Risks related to companies we invest in not being able to secure additional funding,
obtain favorable investment terms for future financings, or to take advantage of liquidity
events such as initial public offerings, mergers, and private sales; and |
||
| There may exist unknown defects of an acquired companys products or assets that may
not be identified due to the inherent limitations involved in the due diligence process of
an acquisition. |
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In the event that an acquisition or strategic investment does occur and we are unable to
obtain anticipated profits or successfully integrate operations, technologies, products, or
personnel or acquire assets that later become worthless, our business, results of operations, and
financial condition could be materially adversely affected.
Our stock price is volatile, which has and may result in lawsuits against us and our officers and
directors.
The stock market in general and the stock prices in technology based companies in particular,
have experienced extreme volatility that often has been unrelated to the operating performance of
any specific public company. The market price of our common stock has fluctuated in the past and is
likely to fluctuate in the future as well. For example, during calendar year 2009, the closing
sales price of our common stock ranged from a low of $4.53 per share to a high of $12.28 per share.
Factors that could have a significant impact on the market price of our stock include, but are not
limited to, the following:
| Quarterly variations in customer demand and operating results; |
||
| Announcements of new products by us or our competitors; |
||
| The gain or loss of significant customers or design wins; |
||
| Changes in analysts earnings estimates; |
||
| Changes in analyst recommendations, price targets, or other parameters that may not be
related to earnings estimates; |
||
| Rumors or dissemination of false information; |
||
| Pricing pressures; |
||
| Short selling of our common stock; |
||
| General conditions in the computer, storage, or communications markets; |
||
| Events affecting other companies that investors deem to be comparable to us; and |
||
| Offers to buy us or a competitor for a premium over recent trading price. |
In addition, Broadcoms initiation and subsequent abandonment of its unsolicited takeover
proposal to acquire all of the shares of our common stock has resulted in volatility in the price
of our common stock. Any other takeover proposal by any third party to acquire the outstanding
shares of our common stock may result in further volatility in the price of our common stock. If a
takeover does not occur following announcement of a takeover proposal, for any reason, the market
price of our common stock may decline. In addition, our stock price may decline as a result of the
fact that we have been required to incur, and will continue to be required to incur, significant
expenses related to the Broadcom unsolicited takeover proposal.
In the past, companies, including us, that have experienced volatility in the market price of
their stock have been subject to securities class action litigation. If we were to be the subject
of similar litigation in the future or experience unfavorable outcomes in any of our pending
litigation, as discussed in Note 8 in the accompanying notes to our consolidated financial
statements contained elsewhere herein, it could have a material adverse effect on our business,
results of operations, and financial condition. Such litigation would also divert managements
attention from other business matters.
Terrorist activities and resulting military and other actions could adversely affect our
business.
The continued threat of terrorism, military action, and heightened security measures in
response to the threat of terrorism may cause significant disruption to commerce in some of the
geographic areas in which we operate.
Additionally, it is uncertain what impact the reactions to such events by various governmental
agencies and security regulators worldwide will have on shipping costs. To the extent that such
disruptions result in delays or cancellations of customer orders, delays in collecting cash, a
general decrease in corporate spending on information technology, or our inability to effectively
market, manufacture, or ship our products, our business, financial condition, and results of
operations could be materially and adversely affected. We are unable to predict whether the threat
of terrorism or the responses thereto will result in any long-term commercial disruptions or if
such activities or responses will have any long-term material adverse effect on our business,
results of operations, or financial condition.
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Our corporate offices and principal product development facilities are located in regions that are
subject to earthquakes and other natural disasters.
Our California and Washington facilities, including our corporate offices and principal
product development facilities, are located near major earthquake faults. Any disruption in our
business activities, personal injury, or damage to the facilities in excess of our currently
insured amounts as a result of earthquakes or other such natural disasters, could have a material
adverse effect on our business, results of operations, and financial condition.
We currently do not carry earthquake insurance. However, we do carry various other lines of
insurance that may or may not be adequate to protect our business.
Our certificate of incorporation, provisions of Delaware law, and any shareholders rights plan
could adversely affect the performance of our stock.
Provisions of our certificate of incorporation and Delaware General Corporation Law could make
it more difficult for a third party to acquire us, even if doing so would be beneficial to our
shareholders. In addition, although we have recently terminated our shareholders rights plan, it is
possible that we may adopt a new shareholders rights plan in the future should general business,
market and other conditions, opportunities and risks arise. The provisions of our certificate of
incorporation, Delaware law, and any shareholders rights plan are generally intended to encourage
potential acquirers to negotiate with us and allow our board of directors the opportunity to
consider alternative proposals in the interest of maximizing shareholder value. However, such
provisions may also discourage acquisition proposals or delay or prevent a change in control, which
could harm our stock price.
Our system of internal controls may be inadequate.
We maintain a system of internal controls in order to ensure we are able to collect, process,
summarize, and disclose the information required by the Securities and Exchange Commission within
the time periods specified. Any system of controls, however well designed and operated, can provide
only reasonable, and not absolute, assurance that the objectives of the system are met. In
addition, the design of any control system is based in part upon certain assumptions about the
likelihood of future events. Due to these and other inherent limitations of control systems, there
can be no assurance that any design will succeed in achieving its stated goals under all potential
future conditions, regardless of how remote. Additionally, public companies in the United States
are required to review their internal controls under the Sarbanes-Oxley Act of 2002. If the
internal controls put in place by us are not adequate or fail to perform as anticipated, we may be
required to restate our financial statements, receive an adverse audit opinion on the effectiveness
of our internal controls, and/or take other actions that will divert significant financial and
managerial resources, as well as be subject to fines and/or other government enforcement actions.
Furthermore, the price of our stock could be adversely affected.
Changes in laws, regulations, and financial accounting standards may affect our reported results
of operations.
New laws, regulations and accounting standards, as well as changes to and varying
interpretations of currently accepted accounting practices in the technology industry might
adversely affect our reported financial results, which could have an adverse effect on our stock
price.
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The final determination of our income tax liability may be materially different from our income
tax provisions and accruals and our tax liabilities may be adversely affected by changes in
applicable tax laws.
We are subject to income taxes in both the United States and international jurisdictions.
Significant judgment is required in determining our worldwide provision for income taxes. In the
ordinary course of our business, there are many transactions where the ultimate tax determination
is uncertain. Additionally, our calculations of income taxes are based on our interpretations of
applicable tax laws in the jurisdictions in which we file.
We have adopted transfer-pricing procedures between our subsidiaries to regulate intercompany
transfers. Our procedures call for the licensing of intellectual property, the provision of
services, and the sale of products from one subsidiary to another at prices that we believe are
equivalent to arms length negotiated pricing. We have established these procedures due to the fact
that some of our assets, such as intellectual property, developed in the U.S., will be utilized
among other affiliated companies. If the U.S. Internal Revenue Service or the taxing authorities of
any other jurisdiction were to successfully require changes to our transfer pricing practices, we
could become subject to higher taxes and our earnings would be adversely affected. Any
determination of income reallocation or modification of transfer pricing laws can result in an
income tax assessment on the portion of income deemed to be derived from the U.S. or other taxing
jurisdiction.
Although we believe our tax estimates are reasonable, there is no assurance that the final
determination of our income tax liability will not be materially different than what is reflected
in our income tax provisions and accruals. Should additional taxes be assessed as a result of new
legislation, an audit or litigation, or determined in connection with finalization of our tax
returns, or if our effective tax rate should change as a result of changes in federal,
international or state and local tax laws or their interpretations, or if we were to change the
locations where we operate or if we elect or are required to transfer funds between jurisdictions,
there could be a material adverse effect on our income tax provision and net income in the period
or periods in which that determination is made, and potentially to future periods as well.
We may need additional capital in the future and such additional financing may not be available on
favorable terms.
While we believe we have adequate working capital to meet our expected cash requirements for
the next 12 months, we may need to raise additional funds through public or private debt or equity
financings in order to, without limitation:
| Take advantage of unanticipated opportunities, including more rapid international
expansion or acquisitions of complementary businesses or technologies; |
||
| Develop new products or services; |
||
| Repay outstanding indebtedness; and |
||
| Respond to unanticipated competitive pressures. |
Any additional financing we may need may not be available on terms favorable to us, or at all.
If adequate funds are not available or are not available on acceptable terms, we may not be able to
take advantage of business opportunities, develop new products or services, or otherwise respond to
unanticipated competitive pressures. In any such case, our business, results of operations, and
financial condition could be materially adversely affected.
Global warming issues may cause us to alter the way we conduct our business.
The general public is becoming more aware of global warming issues and as a result,
governments around the world are beginning to focus on addressing this issue. This may result in
new environmental regulations that may unfavorably impact us, our suppliers, and our customers in
how we conduct our business including the design, development, and manufacturing of our products.
The cost of meeting these requirements may have an adverse impact on our results of operations and
financial condition.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
In early August 2008, our Board of Directors authorized a plan to repurchase up to $100.0
million of our outstanding common stock. In April 2009, upon receipt of an unsolicited takeover
proposal and related tender offer from Broadcom Corporation to acquire us, our Board of Directors
elected to temporarily suspend any activity under the share repurchase plan. In light of Broadcoms
announcement of its decision to allow its tender offer to expire on July 14, 2009, Emulexs Board
of Directors elected to reactivate the $100.0 million share repurchase plan effective July 15,
2009. Through December 27, 2009, the Company has repurchased 2.0 million shares of its common
stock for an aggregate purchase price of approximately $18.2 million or an average of $9.12 per
share under this plan. We may repurchase shares from time-to-time in open market purchases or
privately negotiated transactions. The share repurchases will be financed by available cash
balances and cash from operations. Our Board of Directors has not set an expiration date for the
plan.
Issuer Purchases of Equity Securities
Total Number of | Approximate Dollar | |||||||||||||||
Shares Purchased as | Value of Shares | |||||||||||||||
Total Number | Average | Part of Publicly | that May Yet Be | |||||||||||||
of Shares | Price Paid | Announced Plans | Purchased under the | |||||||||||||
Period | Purchased | per Share | Or Programs | Plans or Programs | ||||||||||||
September 28, 2009 October 25, 2009 |
| | | $ | 81,760,136 | |||||||||||
October 26, 2009 November 22, 2009 |
| | | $ | 81,760,136 | |||||||||||
November 23, 2009 December 27, 2009 |
| | | $ | 81,760,136 | |||||||||||
Total |
| | | $ | 81,760,136 | |||||||||||
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders of the Company was held on November 19, 2009. There were
80,760,159 shares of the Companys common stock issued, outstanding and entitled to vote at the
meeting as of September 21, 2009, the record date. Proxies representing 66,019,964 common shares
were received and tabulated. Two proposals were voted on at this meeting. First, the following
members were elected to the Companys Board of Directors to hold office for the ensuing year:
Nominee | In Favor | Withheld | ||||||
Fred B. Cox |
59,939,380 | 6,080,584 | ||||||
Michael P. Downey |
59,807,503 | 6,212,461 | ||||||
Bruce C. Edwards |
59,773,278 | 6,246,686 | ||||||
Paul F. Folino |
60,007,410 | 6,012,554 | ||||||
Robert H. Goon |
59,727,080 | 6,292,884 | ||||||
Don M. Lyle |
59,515,289 | 6,504,675 | ||||||
James M. McCluney |
60,095,773 | 5,924,191 | ||||||
Dean A. Yoost |
60,549,370 | 5,470,594 |
The second proposal submitted to the stockholders of the Company was to ratify the selection of
KPMG LLP as the Companys independent registered public accounting firm for fiscal 2010. This
proposal was approved with the following votes:
For |
65,099,478 | |||
Against |
828,064 | |||
Abstain |
92,422 | |||
Broker non-votes |
|
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Item 6. Exhibits
Exhibit 3.1 | Certificate of Incorporation, as amended (incorporated by
reference to Exhibit 3.1 to the Companys 1997 Annual Report
on Form 10-K). |
|
Exhibit 3.2 | Certificate of Amendment of Certificate of Incorporation of
the Company (incorporated by reference to Exhibit 3.4 to the
Companys Quarterly Report on Form 10-Q for the quarterly
period ended December 31, 2000). |
|
Exhibit 3.3 | Amended and restated Bylaws of the Company (incorporated by
reference to Exhibit 3.1 to the Companys Current Report on
Form 8-K filed on October 2, 2009). |
|
Exhibit 3.4 | Amended and Restated Certificate of Designations, Preferences
and Rights of Series A Junior Participating Preferred Stock of
Emulex Corporation, incorporated by reference to Exhibit 3.1
to the Companys Form 8-K filed with the Securities and
Exchange Commission on January 16, 2009. |
|
Exhibit 4.1 | Rights Agreement, dated as of January 15, 2009, with Mellon
Investor Services LLC, as rights agent, which includes as
Exhibit B the Form of Rights Certificate, incorporated by
reference to Exhibit 4.1 to the Companys Form 8-K filed with
the Securities and Exchange Commission on January 16, 2009. |
|
Exhibit 4.2 | Amendment to Rights Agreement, dated October 1, 2009, with
Mellon Investor Services LLC, as rights agent, incorporated by
reference to Exhibit 4.1 to the Companys Form 8-K filed with
the Securities and Exchange Commission on October 2, 2009. |
|
Exhibit 31A | Certification of the Principal Executive Officer Pursuant to
17 CFR 240.13a-14(a), as Adopted Pursuant to
§ 302 of the
Sarbanes-Oxley Act of 2002. |
|
Exhibit 31B | Certification of the Principal Financial Officer Pursuant to
17 CFR 240.13a-14(a), as Adopted Pursuant to
§ 302 of the
Sarbanes-Oxley Act of 2002. |
|
Exhibit 32 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to § 906 of the Sarbanes-Oxley Act of 2002. |
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Table of Contents
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: January 29, 2010
EMULEX CORPORATION |
||||
By: | /s/ James M. McCluney | |||
James M. McCluney | ||||
President and Chief Executive Officer | ||||
By: | /s/ Michael J. Rockenbach | |||
Michael J. Rockenbach | ||||
Executive Vice President and Chief Financial Officer (Principal Financial and Chief Accounting Officer) |
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Table of Contents
EXHIBIT INDEX
Exhibit 3.1 | Certificate of Incorporation, as amended (incorporated by
reference to Exhibit 3.1 to the Companys 1997 Annual Report
on Form 10-K). |
|
Exhibit 3.2 | Certificate of Amendment of Certificate of Incorporation of
the Company (incorporated by reference to Exhibit 3.4 to the
Companys Quarterly Report on Form 10-Q for the quarterly
period ended December 31, 2000). |
|
Exhibit 3.3 | Amended and restated Bylaws of the Company (incorporated by
reference to Exhibit 3.2 to the Companys Current Report on
Form 8-K filed on October 2, 2009). |
|
Exhibit 3.4 | Amended and Restated Certificate of Designations, Preferences
and Rights of Series A Junior Participating Preferred Stock of
Emulex Corporation, incorporated by reference to Exhibit 3.1
to the Companys Form 8-K filed with the Securities and
Exchange Commission on January 16, 2009. |
|
Exhibit 4.1 | Rights Agreement, dated as of January 15, 2009, with Mellon
Investor Services LLC, as rights agent, which includes as
Exhibit B the Form of Rights Certificate, incorporated by
reference to Exhibit 4.1 to the Companys Form 8-K filed with
the Securities and Exchange Commission on January 16, 2009. |
|
Exhibit 4.2 | Amendment to Rights Agreement, dated October 1, 2009, with
Mellon Investor Services LLC, as rights agent, incorporated by
reference to Exhibit 4.1 to the Companys Form 8-K filed with
the Securities and Exchange Commission on October 2, 2009. |
|
Exhibit 31A | Certification of the Principal Executive Officer Pursuant to
17 CFR 240.13a-14(a), as Adopted Pursuant to
§ 302 of the
Sarbanes-Oxley Act of 2002. |
|
Exhibit 31B | Certification of the Principal Financial Officer Pursuant to
17 CFR 240.13a-14(a), as Adopted Pursuant to
§ 302 of the
Sarbanes-Oxley Act of 2002. |
|
Exhibit 32 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to § 906 of the Sarbanes-Oxley Act of 2002. |
53